And I’m just talking about the ECONOMIC chaos from the collapse the Fed has already laid in for us.
Danielle DiMartino Booth, a former Fed staff member and CEO of her own financial advisory firm, says the lag time with Fed policy, which I wrote about yesterday, is going to become “extremely important” in the first quarter of 2024. Since quantitative tightening began in June of 2022, we are only starting to feel the effects of that QT now, she says, due to the 12-18 month lag between Fed policy and its effects. That means we will continue to feel the growing effects of all the QT that has happened since then for another 12-18 months.
Before every recession, the Fed tightened, and then we held at a tightening plateau for a few months, as we’ve been doing now. Those plateaus ended, and then recession began, though it wasn’t declared. Then the Fed felt the effects and realized it had overtightened and began fiercely cutting rates.
The plateau between the Fed’s last rate hike and its first cut, according to DiMartino Booth, is an average of seven months long. So, the effects of QT are just beginning, and the average seven-month period from when the Fed stopped raising rates hits in January. The reason the Fed usually takes that long to run back to easing is that the lag time takes that long for the Fed to be able to see who much it has overtightened as the first hints of recession dawn. It does this every time.
My view — not hers — is that inflation will prohibit him from making that cut in the “average” amount of time because, in most past times that make up that average, the Fed hasn’t had any inflation problem to deal with. DiMartino Booth believes deflation is coming soon due to recession. I believe the recession is already hitting, but inflation won’t be coming down to the Fed’s target this soon. I believe we’re entering a stagflationary recession, which is an unusual kind of recession (in that most recessions are disinflationary or even deflationary, but stagflationary recessions do happen, as we saw in the seventies and early eighties but not since).
If the Fed keeps tightening, then we could go all the way into deflation down the road as the Fed succeeds against inflation, but its tightening could also make inflation worse if it damages already short supply chains. It will take months due to the lag tie before we know how bad the damage is. Deflation would leave the Fed room to ease in order to get inflation back UP to its target and to save us from the damage the Fed is now causing. I don’t think the Fed will have that latitude.
Aside from that major difference, we see the rest of what plays out due to fed tightening the same way.
The coming bond-default tsunami
While we believe quite differently on inflation, DiMartino Booth believes, as I predicted in my last “Deeper Dive,” we will be seeing a tsunami of debt defaults in 2024 due to the maturity timing of corporate bonds that will have to be refinanced. I showed pretty clearly with some graphs in that “Deeper Dive,” it think, how much larger that wave of bonds needing to be refinanced will be in 2024 than it was in 2023.
Consider that rising interest on bonds is not a serious default problem for corporations until their old bonds mature and force them back to the bond pits to refinance. They are not forced to feel those higher rates until they have to refinance their current bonds. This year that becomes a sudden wall of trouble because rates are triple what they were paying, and you can see in that “Deeper Dive” what a high wall of water is coming in terms of bond maturity dates. That was the centerpiece of my “Deeper Dive” and the basis of a deeply dark forecast on my part for 2024.
Today Zero Hedge carried an article that covers what has turned out to be my main topic this week – the faltering ripples we’ve just started seeing in the repo market that lubricates banking as the massive reverse repo market (the flip side of that market) drains away. As described yesterday, that has been feeding cash that was sidelined during the QE days back into reserves. ZH says the same thing today.
While ZH says it does not see the kinds of troubles in interbank lending that we had back in 2019 because of the amount cash still banked in reverse repos, they do see the complete draining of that banked cash being accomplished by April and do see that becoming a headwind for markets, which have been fueled in the recent rally by this liquidity source, once it runs dry.
I agree with the last part, of course, but disagree with the idea that repo loans will not become as serious of a problem as they were last time the Fed did QT. Even if they don’t break out as another repo crisis, they are signs of tensions building in bank reserves as the buffer from reverse repos dwindles.
What DiMartino Booth is looking at as the big source for trouble in bond world and the economy overall is QT — not rate hikes or reductions. Rate cuts will be so small, she says, if they do happen this spring as the stock market believes, they will mean “diddly squat” anyway because of the huge downdraft that is still building from QT, which will continue to build even if interest is lowered.
That’s a point I’ve been trying to make along the way, too. QT has much more of a damaging effect to the Fed’s fake recoveries than the Fed believes. (That’s why I call them fake; they can only continue so long as the life support continues, and QT is sucking the blood out of the patient when transfusions are the only thing keeping him alive.) We’ve saw how badly the Fed underestimated the damage to its “recoveries” during the big QT of 2018-2019, as I wrote about yesterday. (See: “Down the Money Drain Hole We Go!”)
She points out, as I have, that Powell has been very clear in stating QT will continue indefinitely after rates stop rising. The market is giving this little attention because Powell acts as if it will be as boring as watching paint dry just as Janet Yellen claimed back in 2017 before QT began under Powell. The Fed learned nothing from that episode. DiMartino Booth mocks the market’s euphoria over anticipated rate cuts, in light of continuing QT by saying, “OH, we’ll only be flogged five times today, instead of six. Whooo!”
She also notes, as I indicated yesterday, that it is only when the reverse repo facility is fully drained that we’ll really feel the affects of QT. That, she says, as I claimed, is because Reverse Repos were built up to be a buffer to eventual QT. The buffer ending in April/May is another factor that will bring the “Year of Chaos” that I said in my “Deeper Dive” is what I’d call 2024.
It boils down like this: We’re going to find Treasury sales pulling money out of the bank reserves in greater numbers due to Federal deficits and see MANY more corporations going back to the bond market at the same time as banks transfer cash for new bonds to the Federal government’s Federal Reserve bank account as the transaction for those treasury sales and between other accounts for the corporate bond sales. That will pile up in a big way right when the RRP facility no longer exists as a huge buffer that has been injecting cash into reserves.
At that point, rate cuts could happen because QT will keep doing the work of tightening the economy even if rates drop a little. But, as I’ve maintained since the Covidcrisis, that will be too little too late to help markets or keep us out of recession because of everything that continues to pile in from the Fed’s Great Rewind 2.0. In other words, there will be as long of a lag time for rate cuts to start to make a positive difference for the economy as there has been for QT to take the economy down. So, while we’re waiting for the effects of a return to easing for months, all the effects of tightening will keep coming in. It’s going to be a huge mess. That is why the Fed has never exited a tightening period without creating a recession and will not do so now even though the market feverishly believes this time will be different than all others.
Maybe it will be different … as in a much bigger train wreck due to the much bigger scale of the prior easing and the current QT to rewind it all.
The salient point for the moment doesn’t require any of that speculation, though. I called it “a mathematical certainty” in my “Deeper Dive,” which is why DiMartino Booth says confidently, as do I, we’ll feel the swell from that default tsunami in early 2024. Many of those defaults will come in the form of corporate liquidations because full liquidation will be the only path out of debt for many when they cannot refinance under the new high bond rates and their own crippling credit ratings.
Clearly a tsunami of corporate liquidations and other forms of corporate default brings its own added economic destruction to the mere pinch we are feeling at the moment, though we’d have to speculate on what that will look like. That it will be serious, however, is no speculation. The size of the approaching tsunami is quite obvious and certain. Sometimes you can tell certain trouble is coming just by seeing the size of the wave that is coming your way.
I see bank reserves becoming deeply troubled once the RRP facility is depleted of all that banked cash that is currently flowing rapidly into reserves to keep them liquified. I see the trembling in repo loans right now as minor foreshocks of a big temblor to come — the kind that creates tsunamis. Readers of the “Deeper Dive” articles get the full basis for my prediction of what is coming due to this huge wave of bonds about to mature and sweep over us. That will happen in the environment of bank reserves that are already troubled by QT, as we saw in spring and as is hinted at again in repos. The forces of past QT will become fully felt just as the reverse repo buffer for bank reserves has been drained.