The other side of the supply shock was always going to be rough. Our only question was just how bad it might get. On that there were two variables, neither of those inflation. From the monetary side, we’d know from the beginning what ailed the global economy was never that. Quite the contrary, money circulation had diminished and as last year wore down, diminished badly.
More trouble in the eurodollar system risked turning the flipside to the supply shock into a full-blown crisis and disaster. Consumer (and producer) prices had been pushed to extremes by the mismatch between demand goosed by government “aid” and the ability of our worldwide production and transportation network hampered by other government faults to deliver.
Nothing more complicated than the most basic of economics.
As businesses figured out the logistics and the pandemic finally got expelled from official priorities, supply began to normalize. More importantly, though, demand dropped.
The combination meant the days of “inflation” were indeed numbered, the whole thing destined to be transitory. And now here we are. Prices are softening, pressures abating, but not the Goldilocks of disinflation we’d been promised.
Rather, the specter of deflation now looms over everything. Initially, officials said the economy was facing no worse than slowing down after a period of too-rapid growth which they believed had led to genuine inflation risks; a sorely needed downshift into something more stable and sustainable.
Nonsense. Never at any time was that in the cards. Policymakers are simply awful at economics. They do themselves no favors by ignoring the wealth of useful data at their – and our – fingertips. All the way back at the very start of December 2021, the eurodollar futures curve had tipped into inversion.
Just a tiny bit at first, but that original morsel told you more about the future than anything coming from any mainstream source since that moment. Two days after it happened, I wrote here in these pages, now it began as is usually the case way down at the far end of the curve.
“Taken literally, that might seem to suggest problems manifesting sometime in 2025; who cares, right? But we know that’s not what inversion means. Like before, the market has judged the probability of trouble – not specific at this point – in the uncertain future to be greater than not; the chances of something not as-yet specified going wrong rather than everything going right, it’s now being thought and priced to be a better bet.”
Worse, this key warning was completely ignored in favor of the money printers; not real money printers, those who fill up the internet with fables of Federal Reserve digits and QE fictions. Those would get all the notice with CPIs on the rise, “Insofar as the mainstream is concerned, it is inflation, inflation, inflation for as far as its tainted eye can see.”
Yet, the countdown to the end of the supply shock began that day even as the world went all-in on inflation la-la land. Even the policy setters couldn’t keep themselves away.
Market participants might’ve guessed Russia would invade Ukraine and trigger an oil shock, but it wasn’t necessary for them to have been so precise. What was bothering those participants that much that December was how the situation, as enough of them saw it, had become too fragile, a global system so heavily imbalanced it would be left far too susceptible to any sort of unwelcome shock.
The probabilities of one rose as did the probabilities for worse and worse cases. Not wanting to leave themselves in the hands of Jay Powell or Christine Lagarde, they began to hedge only a little at first. It was enough to produce that distortion, that inversion, especially as fewer were willing to take the opposite side.
The more time passed, the balance of fears tipped decidedly against la-la land. As I wrote to close out that piece in December 2021, “This rekindled inversion already does indicate a very likely end to the ‘inflation’ narrative of 2021, a welcome development in the narrow sense of consumer prices, yet this would also mean 2022 almost certainly ends up closer to 2019; as a best case."
Now here we are right in that place. It took a couple of high-profile bank failures for anyone, really, to finally realize it. The supply shock of 2021 wasn’t merely about the difficulties when Americans bought stuff on Amazon.com. There was always a monetary issue and danger, beginning with collateral scarcity and the ever-present potential for it to expand into 2008-levels.
This year’s “banking difficulties” aren’t really about the flight of depositors seeking higher money market returns than regional US banks can give them (just ask Credit Suisse, if you could).
Interpreting the eurodollar futures inversion in a technical manner, what it suggested was growing possibilities that no matter how devoted authorities at the Federal Reserve might become to their views on their inflation menace, something was bound to happen which would snap them into reality and completely refocus their priorities. Rate hikes would transform into rate cuts.
Either CPIs would come down quickly on their own, or eventually something else would turn Jay Powell’s attention elsewhere.
But with CPIs shooting higher in at least the early part of 2022, global “central bankers” turned utterly hawkish even though CPIs and PPIs waned. Take a look at the US version of consumer prices, or better still producer prices. Their trend changed in March (as more curve inversions showed up), turned more in June (even higher inversions) then swerved right toward disinflation and deflation by the end of last year (right after inversions went completely nuclear).
This common pattern between CPIs and PPIs matched the growing inversions because prices were being slowed by slowing and even falling demand which markets (correctly) interpreted as confirming every bit behind the original 2021 premise. The more pressures abated, the more curves inverted, the greater the potential for the worst kind of end to the supply shock.
A potential raised exponentially by bad money, collateral scarcity most of all. While the media followed every hawkish utterance of Chairman Powell and his colleagues closely, they missed the dramatically deflationary (over time) interruptions roiling T-bills, J-bills, even SOFR occasionally. Those, however, did not go unnoticed in these markets and were dutifully priced into more inversions.
In other words, a collision. The economic end of the supply shock represented by weak and damaged demand would’ve been bad enough, probably recession on its own. Combine that with the growing monetary issues and severity of its strain, suddenly we’re talking about genuine trouble, crisis level proportions.
And by we, I no longer mean just these markets. Even the hawks at the FOMC find themselves moved by events, coming closer and closer to grasping this. The official minutes from last month’s discussions contain this startling (to those only following the Fed) passage:
“If banking and financial conditions and their effects on macroeconomic conditions were to deteriorate more than assumed in the baseline, then the risks around the baseline would be skewed to the downside for both economic activity and inflation, particularly because historical recessions related to financial market problems tend to be more severe and persistent than average recessions.” [emphasis added]
Econometric models only see this as one small possibility. At least for now.
Before recently, they said it was nothing more than a slowdown so ignore the yield curve. Then they pointed to the unemployment rate and claimed there was no way the economy could fall into recession (this was just two months ago!) Yet, in those same minutes the Fed today admits recession is now its base case:
“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff's projection at the time of the March meeting included a mild recession starting later this year…”
Sure, only a mild one. What will they say next month or maybe the month after?
The fact the first quote from above was included in the minutes at all is a solid indication officials at the Fed on some level know it, too; at the very least, know it is way too great of a possibility to just stay silent.
It’s right where inversions had been months before SVB and Credit Suisse (those two names together in infamy are a good example of how this is a systemic monetary problem rather than strictly a Swiss or US regional bank difficulty).
One of the biggest mistakes (among so many) policymakers made the last time fifteen years ago was to treat every individual failure as an individual failure. To look at first the difficulties those Bear Stearns-sponsored hedge funds were having in early 2007 as unique to those funds. Or in August 2007, BNP Paribas’ money market fund problems as something specific to BNP or just money market funds.
Countrywide. Carlyle. German banks littering TAF auctions. Bear Stearns.
It’s all misplaced. Even the IMF’s chief Economist just this week worried global authorities were going to do it again.
“We can all remember the long time between the failure of an individual institution, whether it was Bear Stearns or Countrywide. Every time, this was treated like an isolated incident, until it wasn’t.”
Those banks and funds didn’t matter on their own, rather each a symptom of much bigger problems, systemic distress that went unappreciated for no good reason. Even though central banks aren’t real central banks these days and have little to no idea what’s happening in the monetary system, it was never necessary to have been a true central banker to appreciate these real dangers.
Curves.
The probabilities of the past few years have been shaped and traded, discounted and displayed for all the world to see and appreciate all the while the people we’re told to look up to, the ones we’re assured have everything covered, they’re instead busy trying to figure out what the next CPI might be by fixating on an unemployment rate which has no correlation whatsoever to it.
Thus, the significance of SVB and Credit Suisse was only to remind them, and the public, of how bad they are at economics and money. A fact which these March FOMC minutes merely reinforced whether intentional or not.
Nothing surprising. No unexpectedness. Even central bankers are being pulled involuntarily onto their long-predicted spot.
The stage is nearly set. For what?
“…historical recessions related to financial market problems tend to be more severe and persistent than average recessions.”
The Fed always follows the markets. Always. If only that had meant something else, that policymakers paid close attention to them. We are finally at the other end of the supply shock and it is everything we hoped it wouldn’t be but knew it would.
If only we really could see someone about that money printing. Now that we’re here, la-la land sounds so much better.
