Recessions are never unexpected, merely hidden behind obvious biases or buried under layers of outdated dogma. Most of the time, any economy is almost certainly expanding, which distorts our sense of probabilities. Since outright contractions seem rare, even exceptional, the occurrence of one is as much of a shock as what typically provokes them.
Those aren’t mere coincidences, however. The public has confused “official” financial and monetary illiteracy for random accidents.
Since no one at the Federal Reserve (or any central bank in practice of standard orthodox econometrics) can see and appreciate what does become blindingly obvious, the vast majority of people are quite understandably led to believe it must not have been obvious at all. But who is the greater fool, the fool or the fool who follows him?
This same stage has been repeatedly set with alarming consistency for decades. Yes, decades. All of which serves as more damning evidence that Economics is not a serious discipline, never to learn from these most consequential mistakes as rather a political ideology in service only to its own ends.
Look no further than this week in Sweden. The guy who famously said subprime was contained is being given Economics’ highest honor for how subprime was not contained.
What Mr. Ben Bernanke did do was dazzlingly distract the public from all the disastrous mistakes his group continuously made – one after another after another – that allowed what was never really about subprime mortgages in the first place to become the professions’ worst performance in four generations.
Now, to be fair to Mr. Bernanke, his incompetence wasn’t at all unique or even unusual. The circumstances may have become exceptional due to it, yet that would’ve been the case regardless of the personnel. In the most perverse turn of events, Ben was exceptionally lucky to have been in that right place at that right time to perform so terribly he could now be lauded for it.
The bumbling that occurred just a few years before had been of a similar variety, just lacking the same level of severity as in 2007 forward. Back in 2000, Alan Greenspan’s Fed was wrestling with many of the same issues absent the full weight of “subprime mortgages.” On some level, these are all recessions if falling on different parts of the same spectrum.
A spectrum that is first located and then better defined by the useful information discounted and priced into the complex marketplaces hardly anyone can interpret because of these same Economics practices. Those quite purposefully exclude deeply fundamental indications such as the yield curve or a more modern though equally potent invention like eurodollar futures.
As the FOMC would in late 2007, very late in the year 2000 the Greenspan Fed looked upon increasingly severe warnings in those fundamentals with puzzled dismay. The Treasury yield curve had inverted – as clear a recession warning as any – way back in February of that year. And as the economy progressed in the wrong way, inversion deepened and spread throughout the curve.
An inversion indicates that a substantial portion of the marketplace is hedging against less-than-desirable potential outcomes by positioning those hedges to pay off when rates in general go lower from where they are or might have just been. As more in the market fear the same not-good probabilities, they join the hedging. As fewer disagree, they won’t take the other side and altogether the curves bend more and further in this wicked way.
From the outside, even if you don’t know exactly what is driving these concerns, they give you a powerful warning that whatever it might be is being widely shared. The more widely shared, the more inverted. The worse the potential for whatever concern, the more inverted.
Interest rates in this fashion, however, are presumed to be determined by this unelected circle of Economists parading around as ideal technocrats. For the market to think, plan, and act independently of the parade route is on a very human level a huge blow to the collective’s ego. There is palpable disdain for these contrary indicators to the point when those become most contrary the more likely and intensely officials are to dismiss them.
How dare they!
Such was the case in November 2000 (just as it would be entering November 2007, or, spoiler, exiting November 2022). The Treasury yield curve inversion had already reversed, though not for any positive reasoning, quite the opposite. It had entered its phase of “bad steepening” where the markets expect more imminent reversal, yields at the front end fall more and farther than those further down.
Eurodollar futures would also come to more heavily weigh in the same fashion. Inverted from the early part of the year, too, the typical small upset down the curve had moved its way forward so that from August and September 2000 its own front end was bent downward by a substantial enough amount; by September 5, the spread between the December 2000 contract and June 2001 had reached -10.5 bps.
Entering November, that same spread had widened to -32 bps. Now this did not mean the market was literally pricing nothing more than an extra quarter-point rate cut from the Greenspan Fed which would then be transmitted – by money dealers – into the eurodollar market in the form of LIBOR – which is what sets eurodollar futures contracts. Rather, the same money dealers who perform those monetary duties were hedging such that there was perceived a substantially higher balance of probabilities interest rates were going to be heading some level lower.
The more inverted, the more confidence in that trajectory as well as how far down rates might “have” to go given the still-unfolding, constantly-evolving circumstances.
At that mid-November FOMC meeting, St. Louis Fed’s long-time president William Poole remarked, “What strikes me is this pervasive sense developing in the market that there’s going to be a policy easing ahead.” To which voting members and the phalanx of staffers all uniformly agreed with Poole to disagree with markets while employing their typical how-dare-they derision (we set interest rates).
“MR. STOCKTON. In terms of the discrepancy between our forecast assumption for the fed funds rate and the markets’ forecast, obviously they’re looking for some combination of either greater economic weakness than we are expecting going forward or a more rapid response by the Committee.”
What is most striking about this pattern, Fed voters, staffers, models all of them concede the fact the economy has clearly stumbled. What they can’t fathom is how it could turn out to be any more than a minor inconvenience.
Officials then, as any time, were far more concerned about what was said, anyway, to be a red-hot labor market causing or further provoking excessive inflationary pressures even as material softening developed.
“CHAIRMAN GREENSPAN. All in all, I think that we have, as all of you have said, a combination of the potential persistence of significant inflationary pressures and an unquestioned increase in overall signs of weakness. In other words, my judgment, and I guess I agree with almost everybody else, is that it would be premature to move to a balanced risk statement.”
The FOMC wasn’t even willing to admit economic risks to the downside had risen enough to give them the same weight as what were imaginary inflationary pressures, let alone how they might have far surpassed those as markets had priced. As far as any useful suggestions in that area had gone, those were, in fact, coming in the opposite way from Alan Greenspan’s interpretation; as admitted by…Alan Greenspan.
“CHAIRMAN GREENSPAN. On the inflation front, we have some very funny numbers. Inflation expectations, even granted the significant rise in energy costs, have not moved. The TIPS implied inflation rate on 10-year issues is about where it was two or three months ago, and if anything it is lower. The University of Michigan survey results, after a slight increase last month, have come back down. The current data are somewhat difficult to read.”
Funny numbers? No. Difficult to read only for those too-far-gone in explicit bias.
Put those together with the strong alarms rising from inverted curves and an entirely consistent picture emerges. But because it is one that aligns directly against the prejudged outcomes of the (useless) econometrics employed by in-over-their-heads bureaucrats, everything is ignored and cast aside so that the truly funny numbers of the regression models can be accepted without the serious and seriously inconvenient challenge.
You may not have known this slice of the buildup, but you know how this all ends. The CPI (or PCE Deflator) had indeed peaked much earlier in the year. In a matter of six weeks – yes, six weeks – this very same committee who time and again declared no good reason for either “greater economic weakness” or a “more rapid response” did actually cut rates at the very start of 2001.
The beginning of the dot-com recession was fixed barely a few months further on.
It is absolutely imperative to understand both what becomes the established facts from useful market-based predictions along with recognizing just how quickly the situation changes at least in that official sense of it.
As I wrote above as well as a few weeks ago, this same stupid process would play out near-exactly only seven years later. Curves would warn, more strenuously this time, a nod to both higher visibility of disaster along with the far worse consequences of it, completely ignored and dismissed by Nobel Laureate Bernanke and his lapdogs.
Within a matter of weeks from their meeting at the end of October 2007, TAF, overseas swaps, and the it-was-only-Great-for-him “Recession.”
Here we are all over again. Markets nowadays have taken 2007’s alarms and upped them a bunch more still. And yet, where is Jay Powell and the FOMC? As of this week’s meeting, they just recited Alan Greenspan’s refusal to “rebalance” economic risks for mostly the same reasons in direct opposition to curve after curve after curve.
And, as always, the more strenuous the inversions the more fervently they are rejected in DC.
The contempt now goes both ways. On Wednesday, Powell on behalf of the Fed made plain his view of more rate hikes that he intends will stick around for longer. And despite this very public display of hawkishness, all the curves not only completely ignored him, they’ve gone even further betting against the Fed.
Should the same sequence play out to its bitter end as it had those previous times (as well as those which came before 2000), the Federal Reserve will, of course, be completely blindsided. Again. The only real question is whether Jay Powell will get a Nobel Prize for the screwup. By Bernanke’s example, such will depend on how destructive that gets to be.
According to the ugliness along these curves, Jay’s looking good for Sweden.