This Is Not a New Economic Paradigm
The 2022 "taper tantrum" is likely to blow over
After a massive unwinding of its financial bubble myriad, China and its languishing economy could be on the mend. Following President Xi Jinping’s preside over a Politburo meeting last month, ending in “a signal of easing,” the People’s Bank of China has cut its reserve-requirement ratio (RRR) for minor, major, and rural banks by 0.5%, unleashing a scrumptious 1.2 trillion yuan into the system. Now, with a “wall of debt” also coming due, and demand for cash continuing to mushroom, Chinese leaders will have more reason to renounce their anti-speculative agenda and turn the liquidity taps anti-clockwise.
As a result, China’s chronically underperforming stock market could not only be about to receive one or two bids but could stifle the western media’s perpetual “Evergrande fear” apparatus. Ever since we’ve entered 2022, economic optimism on the mainland has turned from lackluster to lively, with every major data release out of Asia’s hyperpower revealing an increase in business confidence. The recently renamed NBS manufacturing index, which surveys large-scale, state-owned Chinese companies, rose to 50.3 (above 50 signals expansion), while its parent services index came in hot at 52.7. Plus, in the wee hours of Tuesday, the private-owned Caixin PMI recorded its biggest improvement since August last year, a fierce upsurge of 50.9 from the prior month’s contractionary reading.
The global response was startling. Suddenly realizing it had to reprice growth coming from one of the world’s largest economies, the global financial colossus initiated a monumental selloff in U.S. government bonds. In the space of a few hours, U.S Treasury yields rallied a whopping 9%, sending the MOVE index, the unofficial benchmark of Treasury volatility, up towards all-time highs. This move (no pun intended) suddenly reminded the world of one of the defining features of the cheap money era: how interconnected the global economic machine has become, only this time it showed itself in speculator fashion. Like when Volmageddon — the 2018 mini-crash driven by an unwind of speculators who thought volatility could never return to markets — hit everyone by surprise, the shock factor materialized this time in boring-old bonds.
Declaring China’s potential economic recovery, however, as the sole cause for this sharp rally in yields would be a classic infraction of the narrative fallacy, so even with no other concrete catalyst present, it’s unclear what causal concoction started this mammoth bond selloff.
One element, though, that always impacts its intensity, believe it or not, is the fact that the bond market has become a highly leveraged play. Ever since interest rates in America hit rock bottom in 2008 — and almost stayed there, low Treasury market volatility has forced bond speculators to use leverage to juice up their potential returns. If you think dodgy crypto exchanges enabling 12-year-olds to trade with a hundred times their account balance is a disaster waiting to happen, hedge funds trading “on margin” isn’t exactly much less of a hazard.
The salient difference is that so-called professionals gamble inside the Federal Reserve system’s regulated casino, taking out “repo loans” via one of its three official facilities: “Tri-party”, “cleared FICC”, and “uncleared bilateral”, which allows them to put down just $1 for every $100 they want to toss onto the roulette wheel. This video by One Minute Economics gives a great demonstration of how a repo transaction works in practice:
Around $3 trillion in size, tri-party repo is the most popular facility. Operated by the Bank of New York Mellon, it allows authorized financial institutions, such as money market funds or corporate treasurers, to borrow cash or securities in a user-friendly manner, usually to lend out to hedge funds. Cleared FICC repos, meanwhile, are repo transactions executed via the FICC (Fixed Income Clearing Corporation), a DTCC clearinghouse, the most popular “interdealer market” where dealers fund their operations (i.e. market making). And, if you’re still awake, “uncleared bilateral” refers to bespoke repo trades conducted outside the other two facilities. The Federal Reserve holds no data on this market, and that’s in no way mysterious or spooky.
Now, you're probably starting to think that understanding the modern financial system’s “plumbing” could be more than a lengthy endeavor. You’re not wrong. But, although this will make some people sick to their stomach, glancing at the Federal Reverse’s website helps a lot in quickly comprehending repo markets, but also the modern monetary system as a whole. A lot of conspiracy blabber can be debunked by studying its various sections, dedicated to explaining how the Fed system functions in detail. It's not only super transparent, but also super complex, and will likely have boggled the minds of most high-ranking officials, even some Fed chairmen.
With this intricacy involved, it’s clear to see why a lot of people give up and drink the Kool-aid instead. But if a corporate media journalist with no interest in finance gets tasked with covering a repo market crash, they will probably become more monetarily literate than the vast majority of the finance industry, just by taking the time to examine the Fed’s “interactive maps”. Though, as you can see from below, it’s not exactly a painless assignment:
But regardless of the severity or cause of this epic bond rout, this is not the best time to fret over sunk costs. For the first time in a while, Concoda got the inflation narrative wrong. Thinking markets were about to roll over, we piled into Treasuries and high-quality corporate debt, anticipating the destruction of yet another faux recovery and subsequent cycle peak (way) too soon. Since the bond market hadn’t sold off heavily in the face of a media and finance community insisting inflation was anything but “transitory”, we underestimated the market’s appetite to price in a rise in bond yields, let alone a massive rally. Instead, an inflationary dam had been building up over the past few months, and that finally broke, on no particular news or catalyst, just before Monday’s market open.
We’re out of bonds for now, and we remain skeptical of the recent moves. For starters, a fierce selloff in bond markets should bring up memories of the 2013 “taper tantrum,” when after the Federal Reserve announced it was about to taper its colossal trillion-dollar balance sheet, bond yields surged rapidly but only temporarily. A few months later, markets started to realize, once again, that inflation was indeed “transitory”, and that the global economic machine still possessed a chronic growth problem, which it had contracted during the 2008 financial crisis. Yields then plunged on their path back to zero, and stocks rallied hard in response.
What’s more, the bitter irony of this bond yield rally is the next day we saw a total collapse in the ISM, the most accurate, influential indicator of growth and inflation in America. Along with new orders, the prices paid index component tumbled:
For whatever reason — most likely the plethora of geopolitical events causing supply shocks in every commodity known to humankind — the market has gone against “the fundamentals based on data”: that if inflation and growth have peaked, yields must fall, and that if inflation was here to stay, we’d see the ISM prices paid index continue to skyrocket, justifying an expected rise in not only consumer prices but in yields.
Yet we’ve got none of that. Markets appear to have ignored this sharp plunge in one of the most important, impactful indicators of peak inflation, so it’s totally rational to remain skeptical of the so-called “Great Rotation” from growth to value based on rising yields, a theme that’s become dominant across financial media.
For now, though, yields have continued to skyrocket, with the Federal Reserve recently announcing rates could go higher, exacerbating the move:
… it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate. Some participants judged that a less accommodative future stance of policy would likely be warranted and that the Committee should convey a strong commitment to address elevated inflation pressures.
Markets, of course, are always right even if they’re “wrong”, as they’re just an expression of multiple perspectives jammed into one imperfect mechanism. Whether we’re dead wrong or dead early to this disinflationary — even deflationary — party, the global financial machine will reveal the answer, momentarily. Over the past week, markets have thrown all logic out of the window. It makes no sense for economic data to point to a peak in growth and inflation, for us then to witness the U.S. dollar fall, bond yields rise, gold plunge, and defensive stocks sell off simultaneously.
And if the market wants interest rates to stay lower for longer, and panic-selling stocks is its protest in response to Fed comments, then why on earth has it also sold bonds, sold U.S. dollars, and bought crude oil. Even Bitcoin, for once, is acting rationally, plunging in an economic climate with increasingly tightened monetary conditions.
We have to ask ourselves is this time really different? Maybe the future is inflationary, and we got it wrong? Maybe the hyperinflation truthers calling for a U.S. dollar collapse are about to hit the jackpot? Surely not.
This, of course, remains far-fetched, quite simply, because nothing has changed. The system remains the same. Each time the global machine looks as if it’s about to usher in a new economic paradigm, suddenly, after a “healthy correction”, it reverts to its status quo of plunging yields and skyrocketing asset prices.
If the modern monetary theorists get anything right, it’s that interest rates will stay at rock-bottom. Since we — meaning both Wall Street and mom-and-pop investors — continue to plow massive amounts of capital into zombie enterprises and billionaire grifters’ pockets, we only have ourselves to blame for low productivity and economic activity. But we must support these “investments” because a better alternative for generating high returns does not exist, and we can’t expect to invest in real growth, especially if it’s absent from the real economy to begin with.
We have yet to accept that we live in a post-industrial wasteland disguised by a financial smokescreen that supports our 401(k)s and speculative wagers while acting as an advanced rest-of-world cashier. The real growth exists outside the west in Asia, with the U.S. Dollar functioning as the undesirable facilitator of expansion. The endgame? The entire Treasury curve will go to zero and stay there, creating a further explosion of debt and even more absurd asset prices.
But nobody will be thinking about that today. With key indicators starting to signal peak growth and inflation in the U.S. and the Fed keeping its money funnel wide open, albeit to a lesser extent, we’re about to enter the stage in the cycle where recent market norms gradually become market uncertainties.
The market gods have already punished “aping” into sh*tcoins and investing in vaporware and fake innovation promoted by fake gurus. Now, the widely prevalent buy-the-dip mentality could be the next fad to feel their fury. But these deities will be up against both an investor and retail class so focused on generating yield, to try to outweigh this seemingly hidden rates race to zero, that markets will stay buoyant for a lot longer than anyone, even the most bullish bull, has come to anticipate.