Bloated Central Bank Balance Sheets Are the Real Risk (Will The Fed REALLY Raise Rates And Shrink Their Bloated Balance Sheet?)

Let’s see how The Federal Reserve will handles its bloated balance sheet, particularly with a midterm election around the corner.

(Bloomberg) What a difference 25 years makes. Worried that inflation was about to turn higher, the Federal Reserve in February 1994 began raising interest rates, taking the federal funds rate from 3% to 6% a year later. As it turned out, those worries were unfounded: The U.S. consumer price index barely budged, finishing the year at 2.7%, right where it had started. 

Although inflation in many developed-world countries is now well above those levels — 7% in the U.S. alone — of the major central banks only the Bank of England has started to raise short-term rates. They are now, um, 0.25%. Across the developed world, short rates are still either barely above zero or negative. What’s more astonishing is that even though they have cut their purchases, the Federal Reserve and European Central Bank continue to buy about $140 billion of longer-maturity bonds every month, suppressing long-term yields even as inflation rages.

Some central banks say that rate hikes are coming, but their extraordinary reluctance to deal with actual inflation means it will become entrenched. Not only will policy makers have to raise rates more than they envision, but they will have to cut the size of their massive balance-sheet assets, too. Don’t expect that the process will be anything other than awful for risky assets of all stripes.

Over the last year and a half, inflation has not only accelerated but also broadened. It started with goods prices and has now expanded to services, even in the moribund euro zone. Central bankers and markets still believe inflation rates will come down a lot. The part of the swaps market that in essence predicts inflation in the future is pricing in a drop in the U.S. CPI to 3.6% by the spring of 2023 and to 3.25% the year after. Alas, like central bankers, the inflation swap market’s record is dreadful. In late spring of 2020, markets predicted a CPI of minus 1.35% a year later and staying below zero by the spring of 2022. 

The US Dollar Inflation Swap is a poor predictor of inflation, at least under President Biden.

I’m not suggesting inflation will remain at current nosebleed levels. More likely is that having had a couple of decades of headline inflation that was on the low side — for central bankers, but not for anyone else — we are in for a few years when it remains above their targets.

Short rates will of course need to rise. That is problem enough for markets, but the bigger problem comes from the trillions of dollars of assets that central banks have accumulated on their balance sheets. Taken together, the Fed, ECB, Bank of Japan, Bank of England and Swiss National Bank have some $27 trillion of assets. In 2007, before the global financial crisis, the combined total was a little more than $4 trillion. Central bank assets will stop growing this year, undermining a major source of support for all types of bonds. But if inflation remains persistently high, central banks won’t simply be able to let their assets roll off as they mature, as most assume. They will have to start selling them. That is the big problem. 

Central banks resorted to buying bonds and other financial assets (so-called quantitative easing) for a few reasons. The main one was to drive up inflation and inflation expectations from uncomfortably low levels by injecting more liquidity into the financial system and driving down longer-dated yields. Now that central banks have got much more inflation than they wanted, they will, by the equal and opposite token, need to sell the assets they bought. The longer inflation remains at current levels, the greater the pressure to sell. And they will probably need to do so sooner and faster than most expect and at prices a lot lower than they fetch today. The Fed alone owns about 30% of all the notes and bonds issued by the U.S. Treasury Department. 

To say that central bank purchases have had a large effect on yields would be an understatement. One way of seeing this is to split the yield of a longer-dated bond into the part that reflects the expected path of interest rates over the life of the security from everything else. That “everything else” is the term premium. This should compensate investors for, say, sudden surges in inflation. Clearly, this is no longer true. Depending on what model you use, the term premium on 10-year Treasury reached a high of 450 basis points to 500 basis points in the early 1980s. At the nadir of the pandemic, it was minus 100 points and is now about minus 10 points. To be clear, this means that you get less buying a 10-year Treasury than would be suggested by the expected path of rates over the life of the bond — expectations that are almost certainly too low. 

Term premiums below zero suggest bond investors are no longer compensated for things like inflation.

The driving down of government bond yields also compressed yields and spreads on investment-grade and junk bonds. That was the intent. Junk spreads reached their narrowest level ever in June of last year. With so little yield available in fixed income and central banks seemingly always on hand to bail them out, investors flooded into equities. As a result, many developed-world equity indexes are either very expensive or, in the case of the U.S., not far off their most expensive levels ever based on valuation measures that are a decent guide to future returns. That is what a decade and a half of market manipulation by central banks has done.  

The policies of zero or negative rates and seemingly infinite QE looked idiotic (and were) when they were adopted, and time has not been kind. Paradoxically, they could only be sustained if central banks were wrong, and their policies failed to spark inflation. Now that inflation has taken hold, rates will go up substantially and balances sheets will need to shrink.

What would you pay for fixed-income assets now if you knew that central banks will become, in effect, forced sellers later? I can’t see how any financial asset will escape the damage from the likely lurch higher yields. The way out of these policies will be as nasty as the way in was nice.

Particularly since Fed Funds Futures are pointing toward 6 rate increases over the next year.

At least Treasury Secretary Janet Yellen is wearing her Mao jacket.

Inflation: What The Fed Sees (3%) Versus What Main Street Feels (18%) Bare Shelves?

Inflation is literally burning a hole though the pockets of Americans. The Flexible Price CPI is raging at 18% YoY. The Dallas Fed has their preferred measure of inflation, the trimmed mean CPI, is growing at only 3.05% YoY. The classic measure of inflation, CPI YoY, is growing at 7.12%.

That is of course if you can find things to buy at the grocery store.

I remember when Fleetwood Mac played at Bill Clinton’s first inauguration party. Perhaps Fleetwood Mac can play at the midterm election party commemorating the rampant inflation under Biden’s “leadership”: Bare Shelves.

Wasting Away In Inflationville! Flexible CPI YoY Hits 18%, Highest In History (House Price Growth At 18.8% While REAL Wage Growth Crashes)

How bad is inflation in the USA? Try 18%, based on the Flexible Consumer Price Index.

The Flexible Price Consumer Price Index (CPI) is calculated from a subset of goods and services included in the CPI that change price relatively frequently. Because flexible prices are quick to change, it assumes that when these prices are set, they incorporate less of an expectation about future inflation.

Again, remember that Federal inflation numbers woefully undercount housing and rent inflation. For example, the Case-Shiller National Home Price index (as of November 2021) was growing at 18.8%.

The sad part is that inflation-adjusted average hourly earnings growth of all employees is crashing thanks to inflation.

Wasting away in Biden’s inflationville.

Inflationville! US Jobs Added Surprises At +467k, But REAL Hourly Wage Growth FALLS To -2.36% YoY Thanks To Inflation

Well, the COVID hysteria from the Biden Administration and the media preparing us for a horrible jobs report was … incorrect. In fact, the January jobs report was “exceptional”. 467,000 jobs were added and average hourly earnings growth ROSE to 5.7% YoY.

The bad news? Thanks to surging inflation, REAL average hourly earnings growth YoY FELL to -2.36%.

Unemployment ROSE to 4.0% from 3.9% as more people dropped out of the labor force in January. On the bright side, labor force participation rate rose to 62.2% from 61.9%.

Leisure and hospitality employment (one of the most vulnerable to inflation) expanded by 151,000 in January, reflecting job gains in food services and drinking places (+108,000) and in the accommodation industry (+23,000).

The reaction in the bond market? US 10-year yields are up 6.9 basis points as Eurozone is up across the board.

Energy prices are up (except natural gas futures).

Another day in inflationville.

Lagarde Pivots on ECB Rate Hikes as Switch in Guidance Seen Soon (US 10Y Yield Up 5BPS, Mortgage Rates To Follow)

Its the same all over the WESTERN world as sovereign yields are starting to rapidly rise.

(Bloomberg) — European Central Bank President Christine Lagarde is no longer ruling out an interest-rate hike this year, a pivot toward the tightening stance of global peers that officials privately see materializing with a shift in policy guidance as soon as next month. 

Investors brought forward bets on ECB action as the monetary chief delivered surprisingly hawkish comments citing unexpected record inflation data, contrasting with an earlier statement on Thursday that kept intact its formal view that price increases will ease. 

She spoke after policy makers agreed that it’s sensible no longer to exclude a rate move in 2022, and that bond buying could end in the third quarter, according to officials familiar with their thinking who asked not to be identified because such discussions are confidential. An ECB spokesman declined to comment. 

The result of Lagarde’s jaw boning?

US mortgage rates are rising in anticipation of the US following Largarde’s lead. Powell and the Gang continue to lag.

Where’s The Beef? Challenger Job Cuts At -76%, Initial Jobless Claims Drop To 236K

Between the Biden Administration, Anthony Fauci and the media constantly screaming about the devastating effects of Omicron, I would have expected massive job cuts and a large spike in jobless claims. But alas, the numbers and charts tell a different story.

Today, we saw that the Challenger job cuts for January fell further to 76%. Initial jobless claims fell to 236k. And The Federal Reserve is still hyper-stimulating the economy.

After listening to Biden spokesperson Jen Psaki preparing us for an end-of-times job report, I was expecting today’s news dump to be terrible. But alas, it just looks like another day in Stimulyoptoville.

Hey Jen, where’s the beef? Now that I think of it, Jen Psaki looks like Wendy from the burger franchise. Except that the burger Wendy doesn’t terrify people.

APD Jobs Added Tanks By 301,000 As Omicron Continues To Rage (But Probability Of 5 Fed Rate Increases Remains)

Hey, I thought the vaccine mandates and masks were supposed to stop COVID and its mutations in its tracks!

Instead, Omicron has taken a much bigger bite out of the labor market than expected, data from payroll processing firm ADP indicated Wednesday.

The number of workers on private payrolls fell by 301,000  in January, falling far short of expectations for growth of 225,000 jobs.

This was the first decline in payrolls reported by ADP since 2020.

The leisure and hospitality sector shed 154,000 jobs. Trade, transportation, and utilities dropped 62,000 workers. Other services saw payrolls decline by 23,000. Health and education jobs fell by 15,000. Information technology jobs fell by 8,000 and financial services sank by 9,000.

Manufacturers cut 21,000 positions. Construction declined by 10,000. Mining and natural resources added 4,000.

All told, the services sector’s payrolls fell by 274,000 and the goods-producing sector’s payrolls dropped by 27,000.

The Department of Labor will report the official count for January jobs on Friday. It is expected to show that jobs grew by around 170,000 but that may be an underestimate of the impact of omicron.

Since Omicron can be readily blamed for ADP report, it doesn’t look like it has affected the implied probability of 5 rate hikes over the next year.

Unless, of course, Jay and The Gang are hustling us.

Slowdown! CoreLogic Home Price Index UP 18.5% YoY In December, But Only 3.5% In 2022 (MBA Applications UP 12% In January)

The CoreLogic report on home prices were released yesterday, showing that national home price growth was raging at 18.5% year-over-year (YoY) in December. But the CoreLogic report points to a SLOWDOWN in home price growth in 2022 (Jan 2022 – Dec 2022) of 3.5% YoY.

But the housing market is still blistering hot in January 2022. Mortgage Bankers Association (MBA) mortgage purchase applications for the week of 1/21-1/28 were UP 11.63% week-over-week (WoW).

Refinancing applications were up 18.4% WoW as fear of Fed monetary tightening grips the mortgage market.

Now, The Fed is expected to raise their target rate 5 times or so over the next year AND slow down asset purchases. Mortgage rates are rising in anticipation of the Fed’s withdrawal of COVID related stimulus.

So, the housing market is expected to slowdown in 2022 as The Fed withdraws its ample monetary stimulus.

White House Warns Latest Jobs Data Will Be Ugly Due to Omicron (As Atlanta Fed GDPNow Forecast Falls To 0.1%)

Biden spokesperson Jen Paski and the White House always have an excuse for bad news. Perhaps they watched John Belushi in “The Blues Brothers” for help with “It wasn’t my fault!” excuses.

(Bloomberg) — The White House is lowering expectations for this week’s U.S. jobs report, saying that brief absences of workers due to omicron could overstate the number of unemployed people for last month.

Several White House officials have teed up Friday’s report with warnings, saying that the week when surveys were taken for the January payroll numbers was the height of illness absences in the aftermath of the holidays.

Brian Deese, the director of President Joe Biden’s National Economic Council, said the numbers could be “confusing” as Covid illnesses are recorded as job losses.

“We expect that that will have an impact on the numbers,” Deese told MSNBC on Tuesday. “We never put too much weight on any individual month; this will particularly be true in this month, because of the likely effect of the short-term absences from omicron.”

Biden has repeatedly touted employment data as an indicator of a robust economic rebound, and highlighted the tumbling jobless rate to blunt criticisms about overheated inflation. Friday’s report may still show historically low unemployment, which is based on a separate survey from the one for payrolls and counts temporary, unpaid sick leave differently.

Labor Secretary Marty Walsh and White House Press Secretary Jen Psaki have also delivered warnings that the official January jobs gain may be poor.

If a worker was out “and did not receive paid leave, they are counted as having lost their job,” Psaki said Monday. Nearly 9 million people missed work due to illness in January, when the data were being collected, she said. 

“So we just wanted to kind of prepare, you know, people to understand how the data is taken,” she said. “As a result, the month’s jobs report may show job losses in large part because workers were out sick from omicron.”

Yes, a record number of Americans quit their jobs in 2021. But how many were Omicron-related dropouts versus frustrated Americans is unknown. You can guess which side Biden/Psaki will take.

Economists expect nonfarm payrolls to rise by 150,000 for January — the weakest reading since the end of 2020. The U.S. unemployment rate is seen remaining unchanged, at 3.9%, according to the median estimate of forecasts compiled by Bloomberg.

So, are Dreese and Psaki saying that US GDP will roar back … from 0.1% … if Omicron fades away? And that all the fiscal and monetary stimulypto are going to cease creating problems??


Despite the fear of Omicron in the upcoming jobs report, there are still 5 rate hikes on the horizon to combat inflation … created by the Biden Administration and Federal Reserve as they combated COVID with massive fiscal and monetary stimulus.

But don’t worry, the Biden Administration ordered rapid test kits from China … and they have arrived!

Got Heat? Coal Futures UP 133% Since Jan 1 2021, Natural Gas Futures Price UP 93%, WTI Spot Price UP 82%

“Stay warm. It’s a cold one out there today.” – Congressman Murray from Parks & Recreation.

Yes, its a cold one out there. But the Biden Administration is engaging in reducing fossil fuel supply and pushing towards “green” energy such as inefficient solar panels, eagle-killing wind turbines, and ocean turbines.

As a consequence, natural gas futures are up 93% from January 1, 2021 while coal futures are up 133% and WTI Crude spot price is up 82%.

Any wonder why food prices are up 40%?

Stay warm. It’s a cold one out there today. And The Federal government doesn’t care.