Blog | CB Investment Management

Central Banks Downgrade Their Inflation Priority For Fear Of Recession.

Central bank “stimulus” is forcing market distortions that are unsustainable.  The underlying real economy is not responding as advertised.

“I cannot emphasize the importance of the fact that net National saving is now negative. This only happened during the Great Depression and then in the great financial crisis recession.”

Dr Lacy Hunt

 “The ECB cuts rates as expected (3.75%, down from 4%). The ECB against mandate. Cuts rates with: 1) inflation above target and accelerating in May to 2.6%. 2) Eight euro area countries with inflation above 3%.

The United States’ unsustainable budget deficit is a problem, and interest expenses are rising because the government rejects any form of budget discipline.

 The unsustainable deficit is printing money, resulting in higher taxes and likely persistent inflation.”

Daniel Lacalle

Even with the astonishing swing towards policy “stimulus” over the last 9 months in particular, the US economy is showing multiple signs of stress.  In the short term “stimulus” has perpetuated market distortions and induces spending sugar shocks that prop up GDP. However, for the last several decades, these policies have already proved to be economically ineffective with consistently declining long term GDP growth.

Market participants are highly committed to the bubble which policy makers won’t be able to sustain. It is crucial to make a distinction between excessive liquidity and “stimulus”, which leads to extraordinary speculation and valuations, and actual underlying economic development. They are now moving in opposite directions.

After an easy ride for many years, policy makers and many investors are about to be confronted with the greatest economic and investment challenge of their lifetime.

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Here are the main points this week:

Bloomberg Economic surprise data falls to a 5 year low.

US Labor market is now clearly weakening.

A US recession would put the budget deficit at a chronic level of around 20% of GDP

Central banks are easing into rising inflation

ECB cuts interest rates as it raises Europe’s above target inflation forecast

Janet Yellen brings back QE and Powell cuts QT as US inflation rises

US real disposable income crumbles as the US goes into negative net savings

Credit extended to the private domestic non financial sector falls to a 15 year low

US credit card delinquencies are rising fast

Existing home sales signal recession flag

It is crucial to track the core underlying economic conditions as well as the extreme policy measures in order to compound returns. This requires balancing two opposites. Short term bullish “stimulus”, with long term persistent economic deterioration.

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As economic data continues to underwhelm (ISM Manuf, JOLTs), the BBG US economic surprise index has plunged to its lowest level in 5 years.

The last time full-time employment declined for four consecutive months or experienced over 3 million job losses was during previous recessions.

Finally, the labor market seems to be weakening

Small business owners are reporting decreased hiring plans.

In the past this has been an excellent leading indicator for a rising unemployment rate.

Injections of policy “stimulus” continues at a record pace.

ECB cuts rates as it raises its 2025 and 2026 inflation forecasts.

Janet Yellen effectively restarted QE again.

THE US TREASURY’S NEW BUYBACK PROGRAM

We live in an era of the Great Debt for Equity Swap.

in a Buyback game.

FIRST, the Federal Reserve started it with the introduction during the post 2008 GFC of Quantitative Easing. The Fed bought back existing bonds, thereby driving up their prices and conversely taking bond yields down.

SECONDLY, corporations initiated massive stock buybacks by taking on debt to pay for them. Normally corporations sell their stock through new issuance to raise capital. Today they bleed capital and take on debt to reduce the number of stocks outstanding so the same earnings create higher earnings per share.

NOW, the US Treasury has initiated a Buyback program. They issue more debt on a short term basis so they can buy longer dated coupons, thereby achieving the same thing as QE but for different purposes and more targeted. For the same reasons as the Fed and Corporations have implemented Buybacks for purposes of “manipulation”, so is the US Treasury.

WHY WOULD THE US TREASURY WANT TO DO THIS?

The U.S. Treasury’s Buyback Program according to Janet Yellen serves two primary debt management objectives:

  • LIQUIDITY SUPPORT: It establishes a predictable opportunity for market participants to sell off-the-run securities. Essentially, it provides a mechanism for investors to liquidate their holdings in Treasury securities.
  • WHEN THE MARKET WANTS TO SELL (DRIVE YIELDS UP), THE TREASURY CAN INTERJECT.
  • CASH MANAGEMENT: The program aims to reduce volatility in the Treasury’s cash balance and bill issuance. By strategically buying back outstanding debt, the Treasury can:
  • Minimize bill supply disruptions(ISSUE LOTS OF HIGH YIELD T-BILLS TO FUND BUYBACKS)
  • Potentially lower borrowing costs over time (STOP LONG END COUPONS FROM COSTING MORE TO OFFER THROUGH HIGHER YIELD THAN THE TREASURY WANTS TO OR CAN AFFORD TO PAY)

WHAT IS REALLY GOING ON HERE?

  • Reducing the markets ability to achieve Price Discovery
  • The Mis-Pricing of Risk through market control

Can dysfunctional “stimulus”keep going for ever? It hasn’t worked for small business or even aggregate economic growth for decades and it is having ever less effect even with ever greater extremes.

It is unsustainable. It is distorting everything. It can only delay the inevitable and make it worse than it otherwise would be.

Why do policy makers continue with something that can’t work in the long run?

The cost of a recession is now too high to bear.

Why the US cannot afford a recession: At the end of the day, a government is no different than a business. It has costs (expenditures) and it has revenue (tax receipts). Because of the bleak fiscal position of the United States, a recession will act as a margin call on the debt and deficit. The US government is way out over its skis and over-leveraged, and a recession will act as a margin call. Here’s how: During a recession, expenditures go up and revenues go down- the last thing you want when you are already running a historic deficit (during peacetime and full employment)

Current situation

Currently, tax receipts (revenue) stands at $4.4T and spending is $7.7T Of this $7.7T in spending, Social Security and Medicare are $3.2T, defense is $900B and interest is $1T, leaving us with $5.1T that cannot be cut

Expenditures

During the Dotcom bubble of 2000, expenditures increased by 13% During 2008, expenditures increased by 9% This leaves us an average increase of 11% and would take our total expenditures up to $8.6T

Revenue (tax receipts)

During the Dotcom bubble, revenue fell by 24% During 2008, revenue fell by 32% This leaves us an average decrease of 28% and would take our total revenue down to $3.2T

Deficit

Currently, we are running a $1.7T pro-cyclical deficit, (during “good times”) Using the numbers outlined above, our deficit would blow out to $5.4T. Each and every year. That is a 215% increase in the deficit

GDP and the Deficit

Remember, the government cannot create anything on its own- it must leech off the economic activity of the businesses and citizens within that country. This “income”, as I always put it, is the GDP. GDP is what allows the government to service its debt and to operate Our GDP is currently $27T and with a deficit of $1.7T, is 7% of GDP (again, during peacetime and full employment- this is unprecedented) In the GFC, GDP fell by 4% and during COVID, by 10% Split the difference at 7%, and our GDP will fall to $25T The deficit of $5.4T, as a share of GDP, would be 21% This is full-blown emerging market, money printing bonanza, imminent insolvency sort of a number

Return on debt

The return on each dollar of debt decreases as the debt to GDP increases. If you can get a $1.50 return on each $1 of debt, that’s actually a great deal. However, in Q1 of 2024, our debt increased by $785B and we got $300B of return (GDP)

 

Now we understand what we are dealing with. Policy makers will most likely do whatever they can to keep the economy at least looking good if they possibly can. Investors need to pay attention, market volatility is being suppressed and sooner or later it will break out.

Best Practice is a matter of your Best Interest.


Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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