Unhedged has nothing to say about Powell’s nomination as Fed chairman alreadyThis is a good idea and a good politics, because continuity is needed, and the new Fed chairman is not a hill where President Joe Biden needs to die.If you think there is more to say, please email it to us [email protected] or [email protected]

Growth inflation, real interest rates and debt traps

Well, you will watch this:

According to real-time estimates from the Atlanta Fed that are purely data-driven, economic growth in the fourth quarter is moving towards an annualized growth rate of 8%. Compared with the 2% in the third quarter, this is a huge acceleration, and before high inflation. Tribute to Chris Verrone of Strategas, who pointed out this in a recent report, on the grounds that no one noticed it-it is true, at least for Unhedged, it was completely in the development process. Fell asleep.

Atlanta’s readings are not abnormal either. Verrone pointed out that, for example, the Citigroup Economic Surprise Index, which has been declining for a long time since mid-2020, has been rising since September and has now entered the positive zone, which means that most reports are now exceeding expectations.

Jim Reid of Deutsche Bank called this environment “growth inflation” yesterday. I like this term in contrast to stagflation. But the emerging signs of growth inflation make the refusal to rise in real interest rates even more mysterious. The following is a standard proxy for real interest rates, 10-year inflation index treasury bond yields or prompts:

This chart makes me feel embarrassed as an American. I mean, after tens of thousands of stimulus measures, despite the abundance and profligacy of consumers and companies, the real interest rate is still minus 1%?Come exist, People.

As an analyst, this also embarrassed me, because I have always believed that the soaring inflation, as we are experiencing now, should force real interest rates to rise. The argument of this view is that since high inflation is always unstable, bond investors respond to high inflation by demanding compensation for the possibility of inflation continuing to rise, thereby dragging down real interest rates (nominal interest rates minus inflation). This will not happen at all now.

Looking at the long-term relationship between real interest rates and inflation only makes me feel better. The hint has only existed for a few decades, so in this chart, I used the 10-year rate of return minus the three-year rolling average core consumer price index inflation as a proxy for the real interest rate. This is the result compared to the average core CPI inflation itself:

Interestingly, when inflation peaked in 1970, 1974, and 1980, real interest rates reached or were close to zero. It takes time for fluctuating inflation to drag real interest rates to their peak in the early 1980s, by which time inflation has begun to fall for a long time. Perhaps we are now seeing this pattern repeat itself, and we can expect real interest rates to catch up. Decades of low and stable inflation have eliminated the inflation risk premium from the bond market. It will not come back in a few months. People may need to lose more money before the news passes.

But there is another explanation why real interest rates still lag behind them: we are in a debt trap. Ruchir Sharma, always interesting debate This line was in yesterday’s FT. The idea is that debt is piling up, and any increase in interest rates will make the cost of services very high, harm the economy and cause interest rates to fall again:

“In past tightening cycles, major central banks have generally raised interest rates by about 400 to 700 basis points.

“Now, more moderate austerity policies may put many countries into economic trouble. In the past two decades, the number of countries with total debt accounting for more than 300% of GDP has increased from six to two, including the United States. A sharp interest rate hike may also inhibit Asset prices rise, which usually also causes deflation in the economy.”

I am not sure whether the debt trap hypothesis is correct, but I cannot deny it. Please note that, as Sharma pointed out, it has two flavors.following Robert Frost, We can call them fire and ice. In a fire scenario, higher interest rates will cause asset prices to plummet, thereby stagnating the economy and ending inflation at the same time. In the freezing scenario, interest rates are high enough to end inflation, cooling economic growth over time. Like Frost, I like fire: the last two cycles ended in asset price crashes. Why is it different this time?

Repair the Treasury Bond Market

U.S. Treasury Market Almost collapsed In March 2020, this scared everyone. When things get tough, it is important that people can raise cash by selling Treasury bonds, because if they can’t, almost everyone will default.

We recently interviewed Yesha Yadav, a professor of law at Vanderbilt University, who wrote an article last year blueprint Reform the national debt market. Yadav believes that dozens of primary dealers—mainly large banks—support the liquidity of the Treasury bond market. But they disappeared when they were needed most. In last year’s crisis:

“We have seen price misalignment, disappearance of liquidity, widening of bid-ask spreads, and the out-of-synchronization of Treasury bond prices with the futures market. In terms of the reputation and credibility of the Treasury bond market, this is a disaster.

“[Primary dealers] There are no constraints to restrict them to provide liquidity in the US Treasury market.Which means it is [rational] Let them, as they did in March 2020, in February 2021, In October 2021-simply withdraw from the market. “

Whenever a few companies believe that the risk of participation is too great, the most important market in the world may fall apart. Some measures should be taken in this regard, and the recommendations vary.

Gary Gensler, chairman of the US Securities and Exchange Commission, wants a centralized Treasury clearing house to eliminate counterparty risks in bilateral clearing.JPMorgan Chase believes Supplementary leverageThe requirement for capital to correspond to risk-free assets should be eliminated because it discourages banks from holding treasury stocks. Yadav likes these two ideas, and believes that regulators can reach an agreement with primary dealers that they will trade against the wind during market turmoil. She wrote:

“Such a promise will not be unlimited. But it can prevent the rapid deterioration of trading conditions under difficult conditions. This kind of active market making has once prevailed in the stock market, for example, experts from the New York Stock Exchange provide this service. “

Primary dealers or any other buyers will not enter the panic market unless they do so profitably. Central clearing houses, termination of SLR and liquidity provision agreements will all increase risk-adjusted profits at the margin. But considering the scale of leveraged positions in the modern Treasury market and the huge chaos they can cause, this may not be enough. Unhedged believes that either the Fed will continue to be the buyer of last resort as in 2020, or the market will have to learn to survive without guaranteed liquidity in the Treasury bond market (Wu Yusen).

A good book

Jonathan Chait think Biden’s unpopularity did not come from Roosevelt’s ambitions, but from the stain of hard-line leftists, “a privatized shadow party funded by naive donors, composed of enthusiastic infantry, and implementing an anti-political strategy.” A good interpretation of the increasingly popular view.