The Fed Dilemma is back again. Does the Fed cut to stimulate a weakening economy but exacerbate the yen trade by causing a massive selloff in stocks? Or does it hold its ground?
I agree, how many times in the past 3 years has some “recession indicator” been triggered? Sure, this time may be different (eventually one indicator will proceed a recession, after all.)
If anyone could predict recessions with any accuracy, they would 1) Be unfathomably rich and 2) They wouldn’t tell you.
The biggest problem, in my opinion, is the debt levels. Few seem to be paying attention as the interest payments on US debt are growing into one of the largest line items of the budget, with no end game in sight. No solutions, not even any real proposals for how to deal with it.
You are right, triggering of traditional recession indicators have no longer been working as it is supposed to. The main reason is the monstrous size of fiscal deficits. I mean, even Claudia Sahm herself said that just because her "Sahm Rule" triggered, that does not mean that there will be a recession, as "this time might very well be different" as we live in strange time of extensive financialization of markets and the economy. And with private sector debt levels so low, it is hard to imagine a hard recession of any sorts, rather I think we will have pockets of credit stress in selected areas that create selective slowdowns, the yen carry trade is one example, also commercial real estate is there.
As for the growing debt, it will keep on growing until we have a failed Treasury auction or some catastrophic event of some sort, which will lead to the collapse of the currency eventually. Whether it will happen in our lifetime, I don't know, but it is for sure coming. I don't think (and I being pessimistic here) any amount of productivity gains or AI can close the government's tab. I intend to write on it, let's see if I can put a post out this month. Thanks J.K.
It will become a financial problem when countries stop buying US Treasuries (as they fear that the government won't be able to repay back), causing yields to spike forcing the Fed to monetize and devalue the currency leading to hyperinflation and eventually the demise of the currency. It will still take a while.
but the bid to cover ratio (the index that captures demand for treasuries) has hovered around a steady 2.5 for the last 6-7 years (as in, demand for US treasuries is 2.5x the offer amount), so that would contradict your point wouldn't it ? I am not saying you are wrong, am just saying, we haven't seen your hypothesis take shape, yet. I think your argument is theoretical rather than empirical ...
Back with a vengeance and better than ever, as if that's possible. Excellent subject coverage and perfect sentence structure designed to convey meaty topics in easily consumable bite-size morsels of knowledge. Forever a fan!!
Hahaha, I guess I needed a little break as I felt my writing was starting to miss the punch and thoughts were getting clouded. Thanks Greg for your constant support. Forever grateful.
Thank you Amrita for a well-rounded discussion about the current state of the US economy and the market dynamics.
I believe the Yen carry trade is more dominant by the domestic Japanese investors such as banks, the individuals (“Mrs. Watanabe”, Japanese housewives), and even the entire Japanese government. The exposure is probably 3 times of that of foreign asset managers speculating in the Yen carry trade: How Big Is the Yen Carry Trade, Really? https://www.bloomberg.com/opinion/articles/2024-08-06/how-big-is-the-yen-carry-trade-really
So if the foreigners have unwounded say 50-60% of their positions, what do we know of the domestic investors’ unwinding? Hard to imagine if they all exited their trades and Yen had to keep surging, at that point, the BOJ has to knock down Yen again instead of propping it up🙃!
Thanks Marianne for such an insightful comment and also for pointing me to thee Bloomberg piece, I had no idea how closely JPY was trading in relation to Nasdaq 100. From what I understand, it looks like BOJ had back tracked on their financial tightening stance a little bit, so that has given some reprieve. I don't how long-lasting it will be though.
Yes, it is hard to say volatility can easily subside this time given the valuation and slowdown in the US, with growth not picked up by Europe and China. The Japanese government certainly does not want to be blamed as the source of contagion and not do anything! Thanks for your kind words and restacking!
Breath of fresh air reading that the Fed's short term rates are not the only thing controlling the economy. Seems like everyone will be surprised that when rates go down that the economy will not come roaring back (although the stock market might temporarily). My understanding of the Sahm rule is that it should trigger fiscal stimulus in the form of direct payments to citizens. That will stimulate spending and potentially ward off higher unemployment. Lowering rates, monetary stimulus, takes too long to impact unemployment and contributes to asset inflation (stocks, real estate, crypto, etc). Your substack remains my favorite.
Thanks Tom for your support. 🙏🏻🙏🏻 You are right that stimulating the economy fiscal stimulus props up consumer spending on a nominal basis without actually increasing the capacity of production, which ultimately leads to inflation (the whole sage over the last 3-4 years). In the classic sense, reducing interest rates should work to stimulate certain industries in my opinion, which over the last few years have been squeezed, like real estate, autos and such. One thing that is optimistic was the SLOOS report that came out recently (not mentioned in the post) where loan demand is picking up. If the capex cycle (outside of Magnificent 7) actually picks up in a meaningful way because of financial loosening, that could create a flywheel for more employment, spending, production, so forth. But traditional QE is just asset price inflation, like you pointed out and very little of it actually turns into any productivity gains in my opinion.
The NEBER is a more complex understanding of a reflection of the various M2 components and there impact on production and the time variable… However since the fiasico of 2007-08, the money managers at the Fed and the Venture Capitalist caught up in their own “Too Big To Fail” plan, failed to provide a strategy to disinvest the HUGE amount of capital they accepted by their liquidation of Leman Brothers and the return to liquidity of the Junk bonds that were wrapped up and wrote off. Nevertheless the fix was never really resolved. So when you have Crony Captalism you are forced to change the definition of commonly used terms because of the few selected “winners” are out of step with the
common association with two consecutive quarters of negative GDP growth. If you really want to look at the macroeconomic of Bidenomics you are forced to consider the biological components such as both from a Federal shutdown of small business but with the Federal Government still moving forward with full force of drunken sailors on Holiday leave in Hawaii… Massive amount of spending on closing down the ONLY Productivite part of the US economic engine while importing massive amount of cheap labor force untrained as well as a huge pressure upon all aspects the local community and to make the illusion complete after the economy was on virtual life support checks were sent out (not to those who served in our military and building the schools and hospitals but to the illegally immigrants in the average amount of $2,500.00 a monthly basis… Only in American;)
Thanks for the great commentary. I was especially appreciative of the explanation of the yen carry trade, because I didn't really know what it was all about (maybe because it's something only very sophisticated, wealthy investors - not the little guy - are into) and how it affects the US stock market. Very interesting.
Thank you Al. Glad my explanation helped. You are right, these kind of "yen carry trade" does not affect small retail investors as such, but is used by the big players, hedge funds mostly to use leverage (cheap JPY) to make free money (US treasury bonds at 5.5%, stocks, etc.), until the trade fails like it has now, because JPY is no longer as "cheap" as it used to be. I am carefully watching how this whole thing unravels in the coming days or so.
Thanks again - glad you'll be keeping an eye on it. Actually, it does affect retail investors if it makes the stock market go down - or do you think that kind of drop is only temporary?
You are right, once stocks go down (like it did yesterday), it does affect retail investors, although they were never levered in JPY to begin with.
I will also add that usually such extreme volatile events can also quickly reverse back depending on the currency markets.
However, I do think that this is a situation, where a "rate cut" will not work, rather worsen it, because it will weaken the USD further, which will cause a deeper sell-off, until it becomes a self-fulfilling prophecy to a recession.
would a rate cut really weaken the dollar - in a materially sig. way ? so, a 25 basis points cut in EFFR leads to 6 basis points decrease in 10Y yield, right ? that's not a lot ... and investors can still purchase DJIA, NASDAQ and RUSS - which will keep the dollar up ... no ?
Amrita, thank you so much for sharing ! deeply appreciate it. and loved the depth. but the loans, when they borrow in yen have locked in interest rates so, it's really the yen getting stronger (due to bond rates increasing, which leads to more bond purchases, which leads to more yen purchase ... and hence a stronger yen) - that led to the selloffs, isn't it ?
Well, these are not "locked in" interest rates, these are margin loans, so the interest rate on them is reflective of the short-term interest rates in pretty much real time, so in this case, people who borrowed JPY on the margin at 0%, only to see (after a certain time) that the interest rate has jumped to 0.25% has to pay back higher interest on the loan. Increasing the short-term interest rates, pretty much immediately strengthens the currency at the same time too. So, instead of $1= 160JPY forex trade, it crashed to $1=141JPY, which means you also need to pay back a lot more JPY for the loan that you got along with a higher interest rate. This triggered a margin call warning and therefore, traders started selling stocks/bitcoin etc. to use these proceeds to convert them into JPY and start paying the loans back. The deeper the selloff, the stronger JPY gets, unless there is an intervention from BOJ. Hope that helps.
got it, perfect, deeply appreciate this awesome response. so, when convert USD to JPY, you get less (which leads to a shortfall you need to cover), and then, 0% interest became 0.25% interest, which means you have more of a shortfall as you pay interest on margin loans ... which triggered a margin call. got it ! the reason why I asked is because I know that not all investors use margins to borrow for carry trade, I think some just use their own capital, in which case, its a combination of both of our hypothesis
I hear more and more often of an economic slowdown. It could be true.
The stock market always leads the economy. If the market begins to tank, brace yourself for trouble in the economy. So far, things are "stable." When panic selling set in yesterday, someone (the Buy Side, I assume) moved in and supported most stocks. So no trouble just yet.
Spot on. The sell off in stocks (like the magnitude we saw yesterday) was mostly driven by the "yen trade" than "recession fears" to be honest, unfortunately when household allocation to stocks is at an all time high (like it is today), such an event is a self fulfilling prophecy to a recession. Unfortunately, the Fed's tools in this event are once again pretty useless, cuz it can't print itself out of it.
As for the recession fears, I don't anticipate a hard recession given that private sector leverage is so low, there will be selected pockets of stress, but with the Fed likely increasing the pace of QE from now into next year, liquidity should be flat or slightly growing.
Great wrote up. The Sahm rule has been getting a lot of attention recently. But Claudia Sahm (the women who invented it) has been on a few networks talking about how she expects it to be a false signal.
Thanks Christos, glad you enjoyed it. You are right about the Sahm indicator, especially given that the last month's job report is likely distorted by the Hurricane Beryl. Meanwhile, the whole re-pricing of rate cuts is chaotic at the moment.
Very interesting! I want the Fed's to cut the interest rate back to 4.5% so Americans can start purchasing again. Come on......Christmas is coming. There will be a lot of shopping to celebrate the first female President Harris.
This is the most confusing time for the economy…many positive signals along with concerning signals. Folks tend to grab onto the metrics that benefit them…benefit their portfolios and earning power. I too think we need a rate cut now to start helping segments of society that are hurting. But Jeremy Siegel lost a lot of my respect by calling for an emergency cut of 50 basis points. He should know better that the Fed is not here to support the stock market. He should have known better that markets needed a correction, a breather. As always this was an excellent write up. Thanks, Amrita!
I agree, how many times in the past 3 years has some “recession indicator” been triggered? Sure, this time may be different (eventually one indicator will proceed a recession, after all.)
If anyone could predict recessions with any accuracy, they would 1) Be unfathomably rich and 2) They wouldn’t tell you.
The biggest problem, in my opinion, is the debt levels. Few seem to be paying attention as the interest payments on US debt are growing into one of the largest line items of the budget, with no end game in sight. No solutions, not even any real proposals for how to deal with it.
You are right, triggering of traditional recession indicators have no longer been working as it is supposed to. The main reason is the monstrous size of fiscal deficits. I mean, even Claudia Sahm herself said that just because her "Sahm Rule" triggered, that does not mean that there will be a recession, as "this time might very well be different" as we live in strange time of extensive financialization of markets and the economy. And with private sector debt levels so low, it is hard to imagine a hard recession of any sorts, rather I think we will have pockets of credit stress in selected areas that create selective slowdowns, the yen carry trade is one example, also commercial real estate is there.
As for the growing debt, it will keep on growing until we have a failed Treasury auction or some catastrophic event of some sort, which will lead to the collapse of the currency eventually. Whether it will happen in our lifetime, I don't know, but it is for sure coming. I don't think (and I being pessimistic here) any amount of productivity gains or AI can close the government's tab. I intend to write on it, let's see if I can put a post out this month. Thanks J.K.
Unfortunately we have become the USSA
No one can compete with the government at least in credit creation ability when it has the reserve currency
We now how USSR ended
Defeated by its own incompetence
There have been amazing scenes in real time of incredible incompetence within the USA administration
Border, housing, inflation, debt, senility, war everywhere day after day the hits keep on coming
Crack up boom or just a whimper
that's a political problem JK, not a financial one - at least not the way our congress does things
It will become a financial problem when countries stop buying US Treasuries (as they fear that the government won't be able to repay back), causing yields to spike forcing the Fed to monetize and devalue the currency leading to hyperinflation and eventually the demise of the currency. It will still take a while.
but the bid to cover ratio (the index that captures demand for treasuries) has hovered around a steady 2.5 for the last 6-7 years (as in, demand for US treasuries is 2.5x the offer amount), so that would contradict your point wouldn't it ? I am not saying you are wrong, am just saying, we haven't seen your hypothesis take shape, yet. I think your argument is theoretical rather than empirical ...
Back with a vengeance and better than ever, as if that's possible. Excellent subject coverage and perfect sentence structure designed to convey meaty topics in easily consumable bite-size morsels of knowledge. Forever a fan!!
Hahaha, I guess I needed a little break as I felt my writing was starting to miss the punch and thoughts were getting clouded. Thanks Greg for your constant support. Forever grateful.
Thank you Amrita for a well-rounded discussion about the current state of the US economy and the market dynamics.
I believe the Yen carry trade is more dominant by the domestic Japanese investors such as banks, the individuals (“Mrs. Watanabe”, Japanese housewives), and even the entire Japanese government. The exposure is probably 3 times of that of foreign asset managers speculating in the Yen carry trade: How Big Is the Yen Carry Trade, Really? https://www.bloomberg.com/opinion/articles/2024-08-06/how-big-is-the-yen-carry-trade-really
So if the foreigners have unwounded say 50-60% of their positions, what do we know of the domestic investors’ unwinding? Hard to imagine if they all exited their trades and Yen had to keep surging, at that point, the BOJ has to knock down Yen again instead of propping it up🙃!
Thanks Marianne for such an insightful comment and also for pointing me to thee Bloomberg piece, I had no idea how closely JPY was trading in relation to Nasdaq 100. From what I understand, it looks like BOJ had back tracked on their financial tightening stance a little bit, so that has given some reprieve. I don't how long-lasting it will be though.
Yes, it is hard to say volatility can easily subside this time given the valuation and slowdown in the US, with growth not picked up by Europe and China. The Japanese government certainly does not want to be blamed as the source of contagion and not do anything! Thanks for your kind words and restacking!
Breath of fresh air reading that the Fed's short term rates are not the only thing controlling the economy. Seems like everyone will be surprised that when rates go down that the economy will not come roaring back (although the stock market might temporarily). My understanding of the Sahm rule is that it should trigger fiscal stimulus in the form of direct payments to citizens. That will stimulate spending and potentially ward off higher unemployment. Lowering rates, monetary stimulus, takes too long to impact unemployment and contributes to asset inflation (stocks, real estate, crypto, etc). Your substack remains my favorite.
Thanks Tom for your support. 🙏🏻🙏🏻 You are right that stimulating the economy fiscal stimulus props up consumer spending on a nominal basis without actually increasing the capacity of production, which ultimately leads to inflation (the whole sage over the last 3-4 years). In the classic sense, reducing interest rates should work to stimulate certain industries in my opinion, which over the last few years have been squeezed, like real estate, autos and such. One thing that is optimistic was the SLOOS report that came out recently (not mentioned in the post) where loan demand is picking up. If the capex cycle (outside of Magnificent 7) actually picks up in a meaningful way because of financial loosening, that could create a flywheel for more employment, spending, production, so forth. But traditional QE is just asset price inflation, like you pointed out and very little of it actually turns into any productivity gains in my opinion.
The NEBER is a more complex understanding of a reflection of the various M2 components and there impact on production and the time variable… However since the fiasico of 2007-08, the money managers at the Fed and the Venture Capitalist caught up in their own “Too Big To Fail” plan, failed to provide a strategy to disinvest the HUGE amount of capital they accepted by their liquidation of Leman Brothers and the return to liquidity of the Junk bonds that were wrapped up and wrote off. Nevertheless the fix was never really resolved. So when you have Crony Captalism you are forced to change the definition of commonly used terms because of the few selected “winners” are out of step with the
common association with two consecutive quarters of negative GDP growth. If you really want to look at the macroeconomic of Bidenomics you are forced to consider the biological components such as both from a Federal shutdown of small business but with the Federal Government still moving forward with full force of drunken sailors on Holiday leave in Hawaii… Massive amount of spending on closing down the ONLY Productivite part of the US economic engine while importing massive amount of cheap labor force untrained as well as a huge pressure upon all aspects the local community and to make the illusion complete after the economy was on virtual life support checks were sent out (not to those who served in our military and building the schools and hospitals but to the illegally immigrants in the average amount of $2,500.00 a monthly basis… Only in American;)
“Always room to be pragmatically optimistic”
Always, there is too much tribalism on either sides of the spectrum. Need to remain centered, yet provocative at the same time. 😊😊
Thanks for the great commentary. I was especially appreciative of the explanation of the yen carry trade, because I didn't really know what it was all about (maybe because it's something only very sophisticated, wealthy investors - not the little guy - are into) and how it affects the US stock market. Very interesting.
Thank you Al. Glad my explanation helped. You are right, these kind of "yen carry trade" does not affect small retail investors as such, but is used by the big players, hedge funds mostly to use leverage (cheap JPY) to make free money (US treasury bonds at 5.5%, stocks, etc.), until the trade fails like it has now, because JPY is no longer as "cheap" as it used to be. I am carefully watching how this whole thing unravels in the coming days or so.
Thanks again - glad you'll be keeping an eye on it. Actually, it does affect retail investors if it makes the stock market go down - or do you think that kind of drop is only temporary?
You are right, once stocks go down (like it did yesterday), it does affect retail investors, although they were never levered in JPY to begin with.
I will also add that usually such extreme volatile events can also quickly reverse back depending on the currency markets.
However, I do think that this is a situation, where a "rate cut" will not work, rather worsen it, because it will weaken the USD further, which will cause a deeper sell-off, until it becomes a self-fulfilling prophecy to a recession.
would a rate cut really weaken the dollar - in a materially sig. way ? so, a 25 basis points cut in EFFR leads to 6 basis points decrease in 10Y yield, right ? that's not a lot ... and investors can still purchase DJIA, NASDAQ and RUSS - which will keep the dollar up ... no ?
Amrita, thank you so much for sharing ! deeply appreciate it. and loved the depth. but the loans, when they borrow in yen have locked in interest rates so, it's really the yen getting stronger (due to bond rates increasing, which leads to more bond purchases, which leads to more yen purchase ... and hence a stronger yen) - that led to the selloffs, isn't it ?
Well, these are not "locked in" interest rates, these are margin loans, so the interest rate on them is reflective of the short-term interest rates in pretty much real time, so in this case, people who borrowed JPY on the margin at 0%, only to see (after a certain time) that the interest rate has jumped to 0.25% has to pay back higher interest on the loan. Increasing the short-term interest rates, pretty much immediately strengthens the currency at the same time too. So, instead of $1= 160JPY forex trade, it crashed to $1=141JPY, which means you also need to pay back a lot more JPY for the loan that you got along with a higher interest rate. This triggered a margin call warning and therefore, traders started selling stocks/bitcoin etc. to use these proceeds to convert them into JPY and start paying the loans back. The deeper the selloff, the stronger JPY gets, unless there is an intervention from BOJ. Hope that helps.
got it, perfect, deeply appreciate this awesome response. so, when convert USD to JPY, you get less (which leads to a shortfall you need to cover), and then, 0% interest became 0.25% interest, which means you have more of a shortfall as you pay interest on margin loans ... which triggered a margin call. got it ! the reason why I asked is because I know that not all investors use margins to borrow for carry trade, I think some just use their own capital, in which case, its a combination of both of our hypothesis
No, the Fed should (have) cut rates because it has succeeded in bringing PCE inflation back to 2%
Thomas, it's not back all the way to 2% ... is it ? I read Powell's remarks, and I didn't see 2%
I hear more and more often of an economic slowdown. It could be true.
The stock market always leads the economy. If the market begins to tank, brace yourself for trouble in the economy. So far, things are "stable." When panic selling set in yesterday, someone (the Buy Side, I assume) moved in and supported most stocks. So no trouble just yet.
Spot on. The sell off in stocks (like the magnitude we saw yesterday) was mostly driven by the "yen trade" than "recession fears" to be honest, unfortunately when household allocation to stocks is at an all time high (like it is today), such an event is a self fulfilling prophecy to a recession. Unfortunately, the Fed's tools in this event are once again pretty useless, cuz it can't print itself out of it.
As for the recession fears, I don't anticipate a hard recession given that private sector leverage is so low, there will be selected pockets of stress, but with the Fed likely increasing the pace of QE from now into next year, liquidity should be flat or slightly growing.
Very smart you are, Amrita. Thanks for the detailed reply.
🙏🏼🙏🏼🙏🏼
Needed a post to put things in perspective thank you 🙏🏽
Thanks Andrew, glad you found it useful.
Great wrote up. The Sahm rule has been getting a lot of attention recently. But Claudia Sahm (the women who invented it) has been on a few networks talking about how she expects it to be a false signal.
Thanks Christos, glad you enjoyed it. You are right about the Sahm indicator, especially given that the last month's job report is likely distorted by the Hurricane Beryl. Meanwhile, the whole re-pricing of rate cuts is chaotic at the moment.
Thank you for the shout out, Amrita! Enjoyed reading this!
Thank you Fallacy Alarm 🙏🏻🙏🏻. Huge fan of your work.
Very interesting! I want the Fed's to cut the interest rate back to 4.5% so Americans can start purchasing again. Come on......Christmas is coming. There will be a lot of shopping to celebrate the first female President Harris.
This is the most confusing time for the economy…many positive signals along with concerning signals. Folks tend to grab onto the metrics that benefit them…benefit their portfolios and earning power. I too think we need a rate cut now to start helping segments of society that are hurting. But Jeremy Siegel lost a lot of my respect by calling for an emergency cut of 50 basis points. He should know better that the Fed is not here to support the stock market. He should have known better that markets needed a correction, a breather. As always this was an excellent write up. Thanks, Amrita!