What’s a Punch Bowl?
October 2, 2022 – Weekly Comment
If we fail to apply the brakes sufficiently and in time, of course, we shall go over the cliff. If businessmen, bankers, your contemporaries in the business and financial world, stay on the sidelines, concerned only with making profits, letting the government bear all the responsibility and the burden of guidance of the economy, we shall surely fail…. In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects—if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.
Fed Chair William McChesney Martin, Jr, October 19, 1955. 67 years ago.
In the speech he also quoted NY Fed President Allan Sproul (NY Fed Pres 1941 to 1956):
“Those who would seek to promote ‘full employment’ by creeping inflation, induced by credit policy, are trying to correct structural maladjustments, which are inevitable in a highly dynamic economy, by debasing the savings of the people. If their advocacy of this course is motivated by concern for ‘the little fellow’, they should explain to the holders of savings bonds, savings deposits, building and loan shares, life insurance policies and pension rights, just how and why a rise in prices of, say, 3 per cent a year is a small price to pay for achieving ‘full employment’. They should also explain to all of us—little, big, and just plain ordinary Americans—what becomes of our whole system of long term contracts, on which so much of our economic activity depends, if it is to be accepted in advance that repayment of long term debt will surely be in badly depreciated coin.”
From the Fed’s press conference September 22, 2021, just over one year ago:
If sustained higher inflation were to become a serious concern, we would certainly respond and use our tools to assure that inflation runs at levels that are consistent with our goal.
So that suggests that inflation’s going to be higher this year, and a number—I guess the inflation rates for next year and 2023 were also marked up, but just by a couple of tenths. Why—those are very modest overshoots. You’re looking at 2.2 and 2.1, you know, two years and three years out. These are very, very—I don’t think that households are going to, you know, notice a couple of tenths of an overshoot. That just happens to be people’s forecasts.
Everyone, including the Fed, knows that the transitory inflation call was wrong. In part the Fed kept policy too loose with the noble intention of making sure employment opportunities were available to the most marginalized worker, in a misguided effort to smooth the contours of inequality. It backfired.
It used to be that the Fed was forward-looking in the conduct of monetary policy, with an early articulation coming in the “Punch Bowl” speech Now it is numbingly reactive. That’s apparent from Brainard’s speech Friday. She simply describes possible spillover and cross-border effects of tighter policy, without drawing any conclusions. Here’s the pith of Brainard’s speech, “…we are committed to avoiding pulling back prematurely. We also recognize that risks may become more two sided at some point.” Things are starting to blow up. Nike, AAPL and Rent-a-Center all are early warning systems with respect to consumer demand. No vodka. Just inflation-fighting Kool-Aid.
Despite the UK blow-up, DXY actually closed slightly lower on the week. Inflation breakevens were crushed. From a high of 368 bps in late March, the 5yr breakeven is 210 now. The ten-yr breakeven hit 304 in April and is now at a new low for the year at 215.5. The US curve steepened. While 2/10 only firmed from -52 to -41 over the week, eurodollar spreads like the red/gold pack spread (2nd to 5th year forward) went from -69.5 to -39.5 a 30 bp jump. Red/green ED pack spread (second to third years) went from -52.75 to -38.75, equaling the high since the start of August. SFRH4/SFRH7 had set a new low of -78 last Friday (Sept 23), but ended the week/month at -47.5. These spreads are still deeply inverted, however, a less inverted curve is likely a signal that the Fed is getting close to the end of the tightening cycle.
News this week includes:
Monday: ISM Mfg expected 52.1 from 52.8 with prices 52.0 from 52.5.
Thursday: Speeches on the Economic Outlook from Cook, Waller and Mester.
Friday: Employment Report with an unchanged rate of 3.7%, NFP expected 250k. Average Hourly Earnings expected 5.1% from 5.2% yoy.
| 9/23/2022 | 9/30/2022 | chg | ||
| UST 2Y | 420.5 | 420.2 | -0.3 | |
| UST 5Y | 397.5 | 403.4 | 5.9 | |
| UST 10Y | 369.1 | 379.8 | 10.7 | |
| UST 30Y | 361.0 | 375.8 | 14.8 | |
| GERM 2Y | 191.8 | 175.9 | -15.9 | |
| GERM 10Y | 202.4 | 210.8 | 8.4 | |
| JPN 30Y | 129.0 | 138.0 | 9.0 | |
| CHINA 10Y | 268.0 | 275.0 | 7.0 | |
| SOFR Z2/Z3 | -1.5 | -6.5 | -5.0 | |
| SOFR Z3/Z4 | -72.5 | -54.5 | 18.0 | |
| SOFR Z4/Z5 | -26.0 | -14.0 | 12.0 | |
| EUR | 96.90 | 98.03 | 1.13 | |
| CRUDE (CLZ2) | 78.25 | 78.72 | 0.47 | |
| SPX | 3693.23 | 3585.62 | -107.61 | -2.9% |
| VIX | 29.92 | 31.62 | 1.70 | |
https://www.federalreserve.gov/newsevents/speech/brainard20220930a.htm
