Talking Their Book



The markets are now screaming at the Fed to do something to arrest inflation concern.  Fed governors must now internally debate hiking the fed funds rate…And if the economy and stock market have bottomed, a 50bp fed funds rate should be insignificant.  But many people don’t really believe; they’re just “talking their book.”

Two weeks ago we noted that commodity markets were in position to soar.  Some have broken out; others are in the process of breaking out.  We also have been warning that bonds have broken down.

On Monday we noted that commodities had rallied a multiple more than stocks.  This is definitely inflation investing, despite the braying by the usual suspects that surging oil and other commodities is a sign of growth.  That’s not accurate.

If fact, in the early stages of recovery inflation is tame.  In the 80s oil and commodities declined while the economy grew robustly.  In the ‘90s inflation remained tame during growth.  But in this decade, substandard economic growth was accompanied by soaring oil and other commodities.

Commodities surge at the end of cycles, particularly when the Fed artificially extends the cycle with funny money.  And now we have record funny money.

And to say bonds are retreating due to economic growth is also wrong, with the 80s again as an example.

The financial crisis to date is due to credit and solvency concerns.  When people fear that an entity cannot meet interest payments or repay all or part of the principal, that piece of paper tanks.  But debt without credit concerns remains buoyant; some debt increases in price on safe haven buying.

But if bonds prices tumble, all debt gets marked down; and then there could be more derivative problems.  If all debt instruments decline financial firms’ balance sheets will deteriorate severely.

One reason for the severity of the credit crisis is that too many Street denizens, including model makers, had not experienced a credit cycle turn.  The last occurred in 1990.

This bond bull market commenced in 1982.  Few money managers have experienced the savagery that a bond bear market brings.

Estimates have CDS at $40 to $50 trillion notion value.  Estimates put interest rate related derivates over 50% of the $1.4 quadrillion derivative market.  We don’t have to elaborate about what might be triggered.

If stocks tumbled on Thursday on concern about inflation and the bond market breakdown, the Fed is in deep stuff.  Its intent has been to reflate financial asset prices.  But declining bonds could trump the Fed.

Ben is now chagrined because his effort to prop up bonds, possibly to appease China (after Hillary’s trek there) by announcing a $300B monetization, has produced the opposite of the desired effect.  Ben’s scheme has inflamed inflation concern, as it should have and will continue to do so.

In recent weeks we have also noted that the dollar is close to breaking down. This is the flipside of the inflation coin. And of course, this forces one to consider what China is thinking and what they might do.

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