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The Fed Is About To Unleash Deflation: Deutsche Bank Shows How
When it comes to the Fed's upcoming rate hike, only one simple shorthand matters: higher rates means less liquidity, and vice versa.
What does that mean for inflation/deflation and bond yields? According to the following simple and understandable analysis by Deutsche Bank, nothing good.
Here is the TL/DR version: "5y5y is well correlated with changes in global liquidity and based on recent trends should be closer to 2 percent."
Here is the extended explanation:
Breaking down the breakeven and real yield components verifies that central bank liquidity has been more associated with real yields then breakevens, however the relationship is perverse! Real yields have tended to fall when balance sheet expansion is slowing while breakevens have generally been more sticky. This suggests that risk assets drive (real) yields and that breakevens anticipate a (delayed) liquidity injection.
This is corroborated by also considering the curve. Like real yields 5s10s is well correlated (positively) with real yields. Note that prior to the crisis the relationship looked more “normal” in that expanding liquidity drive yields lower and vice versa. So something has changed since the crisis—this we think is very important and again, will revisit below.
The relationship between 5s10s and 10s in real terms screams 5y5y! And indeed we overlay 5y5y to liquidity there is a very tight, almost scary, relationship. The relationship even predates the crisis. Tighter liquidity essentially forces the 5y5y nominal rate lower reflecting some combination of a flatter curve and higher yields with a steeper curve and lower yields. Fundamentally we think this ultimately speaks to a lower terminal policy rate so that it doesn’t really matter whether the term structure is trying to shift higher or lower but the curve will more than compensate so that if the trend is towards less central bank liquidity, the terminal rate is falling.
Right now the decline is central bank liquidity suggest 5y5y should be closer to 2 percent or below not 3 percent to above. And this is before the Fed has tightened and China has potentially “finished” its adjustment.
And of course the breakdown in 5y5y between real and inflation reinforces the story that it is the real rate not inflation expectations that drive this result. And this is again consistent with the risk asset concern that it is the lack of liquidity that undermines risk assets that in turn drives real yields lower, despite keeping breakevens relatively inflated. One conclusion is that if investors believe that liquidity is likely to continue to fall one should not sell real yields but buy them and be more worried about risk assets than anything else. This flies in the face of recent concerns that China’s potential liquidation of Treasuries for FX intervention is a Treasury negative and should drive real yields higher. It is possible that if risk assets do very well then maybe the correlation with interest rates is broken. But like all these relationships for us, it is easier to work with the correlations that currently persist rather than to predict random breaks. And the potential breaks should be more cheaply hedged rather than making for a core portfolio allocation. I.e. cheap SPX calls based on rates lower. More generally the simple point is that falling reserves should be the least of worries for rates – as they have so far proven to be since late 2014 and instead, rates need to focus more on risk assets.
Deutsche Bank's summary (which we expanded upon over the weekend):
This reinforces our view that the Fed is in danger of committing policy error. Not because one and done is a non issue but because the market will initially struggle to price “done” after “one”. And the Fed’s communication skills hardly lend themselves to over achievement. More likely in our view, is that one in September will lead to a December pricing and additional hikes in 2016, suggesting 2s could easily trade to 1 ¼ percent. This may well be an overshoot but it could imply another leg lower for risk assets and a sharp reflattening of the yield curve.
To be sure, the Fed may be clueless when it comes to forecasting, but it certainly understands (or should) the relationship between liquidity and 5 Year, 5 Year forward inflation expectation rates. As a result, Yellen and company surely realize that a rate hike - a contraction in liquidity - will result in a further steep decline in forward inflation expectations, and the associated negative implications for risk assets, coupled with lower real and nominal yields, leading to further deflation and an even greater need for "unorthodox" policy measures, i.e., QE4.
Which is why, just like when we first presented this peculiar Fed conundrum over the weekend, the only question is whether the Fed is working to unleash deflation on purpose, or by accident?
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Fed needs to choose: A) Harsh return to relying on economic fundamentals. B) A 10 Trillion $ balance sheet and the illusion of growth.
BALDERDASH! POPPYCOCK! BULLSHIT!
Rates rise, marginal producers cannot tote the note and fail, less items are produced, the ones that are rise in price. Prices rise. Oopsies! Better rase rates again! MORE borrowers go under, prices rise again. Repeat, Repeat, REPEAT.
Yeah, this is the opposite result of lowering rates.
This reinforces our view that the Fed is in danger of committing policy error.
The Fed IS a policy error
They wanna set fire to the EM's and teach them a lesson. They can't have the chinese and russians steeping out of line. I'm thinking they will do a token increase in rates as a warning, then as they start taking note of the real state of the economy (they have to be igoring it atm!) the will reintitute QE.
As the Sexy Beast said: No,no,no,no,no. Subsidized rates lead to marginal producers misallocating resources leading to less productivity to be subsidized by the productive economy leading to suboptimal growth. A healthy growing economy has positive real interest rates that help allocate credit and capital to its most productive uses. A deathly sick one has ZIRP forever. ZIRP = There is no tomorrow.
The choice is: A) A very horrible implosion now. B) A very very horrible implosion later.
C) Kick the can
D) Keep kicking the can
E) Keep kicking the can, forever
Repeat after me ... The FED is not going to raise rates. There will be some sort of false flag event in the coming days that will provide a convenient excuse ... mark my words.
They don't need to "create" an event. All they have to do is wait for any one of the current 32 potential black swans to provide the required cover.
Agree DC. The Fed can never raise rates. They know that would crash the economy and the government. Everything is teetering on a razor thin margin. The cost of borrowing increases, then businesses fail. What about all those stock buybacks on borrowed billions. Apple sells and the stock market craters too.
I met with a business owner today that told me his customer base just disappeared. He had 200-300 regulars and now he has 28. It took a year to 18 months to slowly burn, but now he can't meet payroll. He thought business was just in a temporary funk 6 months ago, now it's scary. The customer can't afford the product now. He's not alone.
My business is down 50% yoy. I know many, many other small businesses in the same boat. It's getting weird out here.
I know a small mfg. He was doing OK until recently when his order book went empty. Zero.
The coming crash is going to be a very hard landing.
At this point QE can not have any effect on the real economy because business is skittish. So even if there was some transmission from QE to reality previously that has been further throttled.
The only helicopters the fed have are gov't spending or a gold revaluation. Gov't spending will distort the economy even worse than it is now and drive debt levels even higher. A gold revaluation would result in some distortion as well but it would also serve to remove most private gold from the economy without increasing debt.
Price gold high enough and you have a defacto devaluation of the currency which makes debt easier to service and creates inflationary expectations increasing velocity. Nearly every citizen has a small amount of gold in the form of jewellery which would would be sold to cash in. If the fed or treasury are buying gold then debt free currency is put into the economy. The mining sector would take off like a scalded rabbit creating demand for oil and jobs. The excess production of other metals would keep many commodity prices down hiding the expansion of the money supply.
Specie would disappear from the retail sector and find it's way back to central banks as many would sell to cash in and few would be buying. Gold would flow back to central banks for merely the cost of printing currency. By the time people figured out that they should be buying at the new price rather than selling, any exchange windows could closed assuming that there are any retail level producers (mints) left.
The Council on Foreign Relations know this and are selling a program to central banks around the world. Resistance to the plan will fade if the economy moves into a deflationary spiral. I don't know the details so much of this is speculation.
When you see the JP Morgues and Goldmans of the world start taking serious gold positions you know that action is immanent
Be careful because the FED is here to make the banks solvent and not protect the middle class. And with all the $Trillion$ the banks have in derivatives a small increase in interest rates would only.. Oh wait, carp, shitz, how much in outstanding derivatives do they have again? Uh oh.... O.K. I agree there's absolutely no way this side of Pluto and Neptune they could raise interest rates without sending their buddies, I meant to say banks, off a cliff.
You sir are correct!! Time to implement negative interest rates! QE4, QE5, Stealth QE, ZIRP, anything to save our friends, I meant to say banks.
Even the Fed doesn't believe the Unemployment Rate numbers. It just provides cover for a rate hike. Feels like Fed realizes that QE doesn't work, and the plan is to try to normalize rates, one hike at a time, and manage the fall-out in risk assets.
Good luck with that.
So I do think they will raise rates because they want to raise rates. But the duration of the hike will probably be measured in milliseconds before they start to backtrack and either cut, hint at acut, or float QE4 balloons.
the onlyquestion is whether the Fed is working to unleash deflation on purpose, or by accident?
On purpose, of course. Banks have $2.5 T in excess reserves at the FED. They plan on raising the rate (.25%) that they pay on these reserves.
http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm
Raising rates will probably suck money into US bonds from overseas. So, deflation it is.
the Fed is in danger of committing policy error
Riiiggghhhtt
Dueschbag Bank was aiming to fail faster than Lehman but the dope smokers at Lehman forced the issue.
The German Deushbagers bought most of the bum mortgage crap and deserve to die....
Turn them into a bunch of Credit unions
"Turn them into a bunch of Credit unions"
Savage!
Central banks are policy error.
There sure are a lot of comments around a 1/4 point rate hike. I say fuck it. Lets see if the Fed can make it happen. If they can't then Janet Yellen is truely a dickless wonder and the Dollar is toast.
Dickless? I don't think so.
When was the last time the Fed raised rates during an election year?
When they wanted to switch the winning team to make it seem like the game wasn't rigged, the referees weren't bribed, and the players weren't on steroids.
You can't delete a comment, just put "dup." for duplicate or a period.
5 times in 2004 maybe? 3 before the actual election?
1% (May 4) -> 1.25% (June 30) -> 1.5% (August 10) -> 1.75% (September 21) -> 2% (November 10) -> 2.25% (December 14)
how do you delete a comment?
You lick your thumb and stick it up your ass.
Wait, that's something else.
You have to put up with being a dumbass. Happens to all of us.
The order of operations is important.
you can't if someone posts a reply. if someone hasn't posted a reply just backspace it out then leave one character like a period or something, it can't be blank
GOLD will be waiting for the masses
Don't plan on it.
Come on Janet you can do it. Just a tiny 1/4% rate hike to show the markets who's the boss. Please do it and get this show started.
Don't worry about the stock market collapses around the world. HA, HA, HEH. JOHNLGALT. Who is John Galt?
<----------- Eastbound Comet.
...Because the conundrum is not that the world lacks John Galts.
The fact is that the world lacks Eddie Willers.
We seem to have a ton of anti-Eddies-- guys just "doing their job" shooting sprinting NAPAs.
Rates will rise when the current Dollar needs to be killed. The new 'shit' dollar will be sold as cool i.e. digital.
Here are some more signs of a recession.
http://michaelekelley.com/2015/05/29/mergers-and-acquisitions-set-record...
http://michaelekelley.com/2015/02/20/fed-warns-of-two-bubbles/
http://michaelekelley.com/2015/02/24/would-you-pay-39-more-than-asked/
http://www.zerohedge.com/news/2015-07-27/when-will-we-ever-learn/
Here is how to respond.
http://michaelekelley.com/2014/10/16/8-things-to-do-when-recession-happens/
Here is how to get your mind off this stuff.
http://michaelekelley.com/category/humor/
Good luck!
Gold and silver are lifting off in Asia tonight as Abe and his unimaginable money printing devalue the BoJ fiat currency double time.
!
Lack of liquidity? What are you talking about. The banks have more money in excess reserves, which is collecting interest, then the entire fed balance sheet. How can banks lend to other banks if their money is tied up in excess reserves? How can interest rates rise when the problem is that there are not enough qualified borrowers borrowing enough money to support the economy (via inflation). Your article is nonsense.
some deflation in the main street economy might be welcome by those for whom hamburger is getting expensive. Then of course we have the "new pound" which now weighs 14 ounces. Money is slowly being withdrawn from the main street economy and this will certainly limit demand but whether less demand translates into lower prices in the dual economies of main street-wall street remains to be seen. The contraction of the money supply from the main street economy means it will slip into recession and then depression if left unresovlved . The Fed of course could give a flying fuck about the main street ecoonmy so a depression there is more than likely going to get worse.
14 oz? I think you mean 12 oz. At least that's what I'm seeing. Luckily we have a family of 3 so still 3 servings of most things for now.
Got a package of bacon recently, top half of the package was empty plastic, only 11 slices of bacon.
Deflation eats it's own tail. After things get bad enough, people turn to barter and the jig is up for realz. In the end I think that is what the oligarchs fear most; that things will fall apart until we are forced to find other means -- and then we'll realize suddenly that we do not in fact actually need them after all.
Think about that one, and then think about everything else you thought was real but just maybe probably isn't.
More Wall Street threats not to raise rates to .25% or the world will end.
It's not wall street, it's government! Government can not afford to pay the interest on the debt they accumulated since 2008!
It's not government, it's a corporation, to which an idiotic government has subcontracted the most important aspect of their economy!
Also, the debt's been accumulating since JFK was assassinated, no thanks to supply-side fucktards such as yourself.
Why would DB be so afrait of a re-pricing of short term rates by an interest rise of 0.25%... Especially when you consider the massive liquidity in Euro that DB has thanks for Dragui's QE...
My amateur response to your question is simple. A 1/4 percent rise on a debt fueled recovery will reverse all of the gains made in the stock market - not because of the 1/4% rise but because it signifies a rising rate environment! When borrowing costs rise the debt increases - obvious right? I am sure some will respond that this is non-sense, but when you calculate what happens to the US Federal Debt when interest rates rise by a single 1%, you will be surprised to find that the debt grows by over $190 Billion! That is an astonishing figure!
The FED has been talking about raising rates for the last 4/5 years and they haven't pulled the trigger - The FED is in a quagmire and I believe that the US will see a dollar crisis before they raise rates. It will be done out of force and not choice.
A quarter point rise on a one percent interest rate equals a twenty-five percent increase in interest charges.
Technically, the FED doesn’t have the problem. We do.
How many people do you know with paid-off real estate? Everyone you know who doesn’t have a paid off pad is a free-loader risk.
Once liquidity dries the machine goes into reverse multiplier effect. All those people you know who don’t have paid-off land are going to show-up on your porch.
Not sure if that is how it will work. My assumption if interest rates go up:
1. Prices of things people use every day will go up because working capital costs will go up.
2. Capital item prices (such as real estate) will come down because people will not be able to afford the high prices with higher interest prices and for existing inventory, there are no working capital costs, only sunk costs and financing.
There does not appear to be a reason to blend these two inflationary/deflationary effects to get something that is wrong all of the time.
Forget economics as it was taught to us in school. There is no free market, so none of the school-taught rules of supply and demand apply.
Repairing Krugman's broken window falls into category 1. It will cost more with higher interest rates.
A capital good is a CNC, robot.... equipment and machinery.
Consumer goods are couches, TV’s, etc.
expansion -> peak -> contraction -> trough
-> flatline
What you are talking about is called stagflation, we've seen it before in the US (early 70s, 83, 92...).
Supply and demand were already mortally wounded once credit (and furthermore government-backstopped credit for the criminally insane) became part of the equation. But prices may actually go down for consumers, it just won't be for a good reason and won't affect staples like food and housing; great deals on nailguns for the unemployed who can't afford them though and for anyone who stays employed (look at the differential in employment between college grads and high-school only to see which people will be living in your basement).
Skyrocketing inflation would be the result of the economic plans of say Trump, bringing all the jobs back to America would have consequences that most people do not contemplate while trying desperately to pay off the card on which they've charged a house full of cheap Chinese everything.
My kid doesn't know the broken window fallacy, but he does have good 'cookies and beer' fundamentals (if you break this, we'll have to buy another one, and we'll have less money for cookies and beer).
5 basis points...just 5. Or 1 basis point every 2 months for a year. My gosh...we cn handle that.
release the hounds.
Introducing the all new, "QE4 Rate Hike Policy" !!!
How about this ? A 25bp rate hike will roil specific markets like equities. It shall trigger rotational shift to Try/$ bond - no illiquidity in this space. Inflation expectation (expectation is nebulous stupid) is not the mechanical science outcome of liquidity trapped in safety assets where global debts are not first down. If inflation expectation do reach 2%, it is not caused by the presence of a singular liquidity in a one asset class. This is another Deutsche Bank's Spin. Go bet on this snake oil and be forewarned that DB's desks are not making markets on their own Spins.
Trichet moved the ECB rate from 4% to 4.25% in June 2008.... look how well that worked out for him
www.teamramgold.com/about-us to join me in karatbars
I think neither. They know they missed their window on the rate increase so it has to happen (thanks to the obvious conclusion that ZIRP hasn't worked), and they do so with full knowledge that it must (and will) be coupled with QE4, if not coincident, then soon thereafter. And then hope for the best. And who knows? It might work to kick the can down the road some - lets face it, that's all they really care about anymore.
If you have to ask if the fed is doing this on purpose or not...then you haven't been doing your homework. They are either EVIL or STUPID. They are evil and the Amerikan people who emurse themselves in useless sports stats playing Fantacy Football and following the Karcrapshians...thay are the STUPID ones...
Has it occured to anyone that this is all part of a masterplan to purposely cause deflation?
TPTB are pushing for a cashless society. When the need arrives for negative interest rates their friends, the bankers, will need protection from the average person trying to protect themself by taking their cash out of the banks. After all, those banks will need those funds for the bail-ins to come.
Deflation is the excuse needed to go to a cashless society. (It's for the children.)
Near zero interest rate hasn't exactly overheated the economy and if you believe Govmnt stats has yet to create inflation- a 25 basis point increase- is not or shouldn't be a good enough reason to leave equities and move money to fixed income investments. And in all reality if that move causes that much panic- we're more f-ked then we thought.
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