Fed balance sheet bubble egregious, but good for WA.

Loose and slack monetary policy in the U.S. may not favour our exchange rate, but along with upcoming fiscal stimulus there and in Europe, it does point to more rocket fuel for segments of our economy, here in WA.

Accommodative monetary policy (low interest rates, high equity valuations) is the fuel for a global electrification and decarbonisation boom.

This boom requires significant inputs from WA, from mining to mining services/products and technical and professional services that support these industries.

And then there’s our innovation space which includes everything from mature businesses to start-ups.

With a mooning Fed balance sheet and more stimulus (monetary and fiscal) destroying the value of money on one hand, there are some silver linings for WA on the other hand.

Here are a few thoughts for why this will continue to provide stimulus for the WA community.

The biggest bubble blowing Fed Chair in U.S. history.

In the shadow of the Grand Tetons at the Jackson Hole Economic Symposium last Friday, U.S. Fed Chair Jerome Powell continued adding helium to the biggest asset bubble ever blown by a central banker.

His comments confirmed that he’s still a dove at heart and will continue to keep the punchbowl of worthless money full, for the foreseeable future.

Basically, destroying your and my purchasing power while money remains in fiat form …….which is why our money has found other places to hide 😉

Here’s what Powell said:

“That brings me to a concluding word on the path ahead for monetary policy. The Committee remains steadfast in our oft-expressed commitment to support the economy for as long as is needed to achieve a full recovery. The changes we made last year to our Statement on Longer-Run Goals and Monetary Policy Strategy are well suited to address today’s challenges.
We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment.
At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.
The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis.”
U.S. Fed Chair Powell, Jackson Hole, 2021.

So, what does he mean? 🤔

Basically, he’s ticked off the inflation precondition to a taper (i.e., a slowing of asset purchases) and feels they’re on the way to maximum employment, but all he can muster is “it could be appropriate to start reducing the pace of asset purchases this year”.

Still no change. The punchbowl is full and getting fuller with no specific taper date or level set.

Even if a taper starts this year, the Fed’s balance sheet will moon for a very long time because a taper is simply an easing off of asset purchases, not an unwinding of the $8,332,743,000 balance sheet, and not a more potent interest rate hike.

While the Fed balance sheet and the economy both stay bloated with ample collateral and liquidity, it moons bigger and higher as more and more people and corporations see no reason to move out of risk assets – and in truth, they buy more.

Think 1928. 1999. 2008. See the pattern?

Powell, it appears, has ripped the crown away from ‘whatever it takes’ super Mario Draghi, and is now the undisputed ex-Goldman Sachs pied piper of bubble infinity.

How did the Fed balance sheet moon and is it concerning?

Ex-Chair Greenspan created the modern balance sheet (fiat) bubble when he blew it 40 years ago after Ford and Nixon trashed the gold standard.

Over time it deflated in good times and reinflated when shocks happened that sucked liquidity out of the bond (collateral) and credit markets.

Bernanke blew an even bigger bubble after the GFC at the end of 2008 to rehydrate bond and credit markets, and Powell then blew it 5 times larger.

And then came that killer virus 🦠🦠

In response, Powell hijacked the death star and attempted to blow the shit out of it (or so he thought) with his multi-trillion death ray.

Powell’s little demonstration has so far taken the Fed’s asset purchases to $8.33 trillion as measured on 26 August 2021 – and it’s still mooning at $120 billion in treasuries and mortgage backed securities, each and every month.

Recently there’s been talk about a taper of the $120 billion in incremental monthly top-ups, and markets had been expecting Powell to either say nothing, or to provide a date at Jackson Hole.

He did neither. He actually made it moon some more…………….

How did markets react?

They partied hard 🥳🎉

Bonds and equities rallied on Friday as Powell.

The 5 year bond yield fell by more than 5% and growth equities popped 1% in a 25 minute window after his speech.

And the beat goes on.

Will a taper actually happen?

That’s up to Powell and his team, but if it does, it will likely be slow until it stops and possibly goes into reverse, just like last time.

Don’t forget all a taper (if one happens) will do is stop the Rohypnol spigot from dripping, but it won’t empty the punchbowl because a bit like an over-filled concrete pool, if you drain it below a certain level you crack it. 🙄

So, while a taper is plausible and healthy despite it probably being way too late in the day, any material and sustainable shrinking of the Fed’s balance sheet thereafter, is not.

In fact, to stop the QE train to nowhere and all that goes with it:

Banks, borrowers and lenders would have to say goodbye to loan collateral (i.e., bond and equity markets would crash, making collateral worth nothing).
Households would lose wealth like during the Great Depression given a lot of it has been moved into equities and other risky investment assets due to nil real interest rates.
The U.S. treasury would have to say goodbye to its main funding source because the Fed makes up between 25% and 30% of all treasury buying and because many businesses would go bankrupt and taxes would dry up.
Foreign governments would not be able to afford their U.S. dollar denominated debt.
The world’s interest bill on roughly $380 trillion in global debt would go up by $3.8 trillion for each 1% increase in interest rates.

Not gonna happen, unless forced by another catalyst because the costs outweigh the benefits until GDP, real growth and wages moon, which seems somewhere way off past the horizon.

So far the only moon is the combined central bank balance sheets and the more that moon breaks earth’s orbit, the less buying power our fiat has, and hence we stay in shares and other risk assets.

What now?

The central bank balance sheets remain trapped between the moon and Kansas City where the infinity punch bowl has been renewed while pundits wait for the next cues at the September FOMC meeting.

Secondary markets light up and capital raising and M&A go into overtime 🧨🧨

Delta and Lambda play out. Maybe growth slows big time. Maybe it doesn’t.

If it does, it will likely be a catalyst for a risk-off move and a pullback in markets.

If not, price action continues up to the right, regardless of fundamentals.

Who can tell? Not even Powell.

But what is certain is that Jerome Powell goes into the record books as the man with the biggest bubble blowing bazooka in modern history that’s blown the most egregious bubble there ever was and caused every other key central bank to do the same.

Today, the Fed, ECB, BoJ and PBoC combined balance sheets have mooned to $30.3 trillion, and that’s more than 1/3rd of global GDP.

And for West Australian industry?

Setting aside the palliative central bank balance sheet issues, low interest rates and high equity valuations create a perfect storm for capital raising and growth via acquisition.

And down here in WA we’re positioned well to ride the electrification/decarbonisation train and to contribute to the global innovation effort, which needs funding.

Our key primary industries are set to continue on strongly if state and federal governments don’t do anything stupid, and shareholders need to realise that wage push inflation is all part of being in a boom, just like the first iron ore boom. Margins contract a little.

Positioning in competitive landscapes for non-commodities based businesses becomes critical.

Positioning for exchange rate volatility also becomes important, particularly for exporters.

Managing supply chain disruptions for WA importers remains a challenge, as the virus continues to morph and disrupt. But volume increases for online businesses in particular help to offset exchange rate and supply chain bottlenecks.

For others, better and smarter business models emerge, and grant and equity funding materialises.

Overall, companies diversify and innovate, seeking to catch the electrification/decarbonisation train, or the fintech train, or even the nascent metaverse coach.

Our innovation ecosystem continues to develop aided by mature businesses with big balance sheets, all the way down to start-ups, plus strategic investment from the right audiences, and we slowly (ever so slowly) arrive at a reopening plan that Premier McGowan can support.

Make no mistake, it needs contributions and incremental changes and reinventions from all of us for this level-up to occur.

And if we make all of those planets align, WA moons.

Mike.

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Powell’s egregious moon good for WA industries