Jim Bianco Warns "Inflation Is Going To Be A Game Changer"

Tyler Durden's picture

Via Christof Gisiger of Finanz und Wirtschaft,

James Bianco, president of Bianco Research, thinks that the Federal Reserve will have to jack up interest rates and the US stock market is running into trouble.

The party on Wall Street is on. Since Donald Trump’s election victory the Dow Jones Industrial advanced more than 15%. This week, the famous stock market indicator traded for the first time over 21,000. Jim Bianco takes a cautious stance. The influential market strategist from Chicago thinks that inflation will soon become a main concern for investors. In his view, this will change the basic relationship between stocks and bonds and could set up the financial markets for severe turmoil, like in the late 1990s when the collapse of Long-Term Capital Management sent shock waves around the globe.

Mr. Bianco, the US stock market is in record mood. What’s your assessment of this rally?
This market has just been grinding higher and higher without any belief that there are any problems. Equities are at an all-time high and volatility measures for the stock market are way down. The S&P 500 has now gone nearly a hundred days without a correction of 1% or more. That’s one of the longest such stretches ever. The last correction of more than 1% was in early November, right before the election. Also, if you look at some of the economic data you’ll see that consumer confidence is at an 18-year high, business confidence is at a 30-year high and the NFIB Small Business Optimism Index is soaring as well. So if you look at all that you would come to the conclusion: «Wow, things are good!»

But then you turn on TV-stations like MSNBC, Fox News or CNN and they’re hyperventilating about Trump and what he said or didn’t say. This is not what you would expect given these all-time highs in confidence and in the stock market. So you’ve got two diametrically opposed things going on and I think to some extent it’s signal and noise: The market believes that Trump is very business friendly, a pro-growth president who is going to cut regulations and taxes. All the rest of this stuff doesn’t matter.

So are there more good times ahead?
The market is in the belief that we are going to get reflation and it’s trading on that belief. Basically, I agree with that. But the real question is what kind of reflation we are going to get. Are we going to get real growth which translates into earnings like the market believes? Or are we going to wind up getting mostly inflation? And that’s what I would argue for. I think that there is an incipient inflation coming and the market is not ready for that.

What does that mean for investors?
Inflation is not quite here yet, but it’s coming. Since the financial crisis we’ve talked about it from time to time. But it has never ever arrived. Now, you’ve got all of this optimism that Trump is going to do this and that and the economy is really going to grow. That’s why the markets are going ahead. But if we get inflation it’s going to be a real big problem. It’s going to be a game changer for the economy and for the markets.

The most basic relationship there is is the relationship between stocks and bonds: when bond prices go one-way how do stocks react and vice versa. This is not a stable relationship. It’s not something you can write into a textbook and teach everybody at business school. There are times when the movements of stock and bond prices are highly correlated to each other and then there are times when they are not correlated and move in the opposite direction. The premise here is that the stock bond relationship is not stable. It changes over time.

Why is this so important?
From the mid-1960s to the late 1990s stock and bond prices were highly correlated to each other: They moved up and down together. When rates went down stocks went up. During this period what you had was an inflation mindset. Everybody was worried about inflation and during the period of high inflation in the 70s stocks got crushed. Especially on an after inflation basis they did very poorly.

And what happened next?
Around 1997/98 you had a regime shift. Now, bond and stock prices started to move in the opposite direction of each other. When such a regime change happens you get a lot of stress in the financial markets. In the late 1990s we had Long Term Capital Management collapsing, we had the Asian financial crisis and we had the Russian debt moratorium. Markets got all stressed out.

So where’s the connection to the present situation?
Since around twenty years we mainly worry about deflation: When we are relieved that there is no deflation yields go up and stocks go up. When we are worried about deflation yields go down and stocks go down. So when we have a regime shift back to an inflation mindset this will put a lot of stress on the financial markets because the relationship of how bonds and stocks react to each other is not going to work anymore the way you think. It’s going to change.

Where would you see early signs for such a fundamental change?
To be clear, the stock bond relationship hasn’t changed yet. But you will know it’s happening when you see turmoil in the financial markets, especially when risk parity funds start to blow up. Risk parity funds, an investment concept pioneered by Bridgewater Associates, are basically an artifact of the deflationary mindset. They trade the stock-bond relationship based on how it’s been for the last twenty years. So if this relationship changes you could either look at all of these correlation charts, or you could just open up The Wall Street Journal or watch CNBC, and you’ll hear stories about risk parity funds blowing up because their models aren’t working anymore. Basically, the same thing that happened with Long-Term Capital Management could happen with risk parity funds in the next regime change.

How does the Federal Reserve fit into this picture?
The Fed is very accommodative right now. They’re way too easy but it’s okay because we don’t have inflation. So some people may say: «Hey, a little inflation wouldn’t be a bad thing because if it reverberates it would get the economy moving». That might be true if you get a little inflation. But once inflation gets going it’s usually hard to stop at that point.

How come?
The Fed says that if we get inflation they’ve got the tools to respond, namely raising interest rates. That’s 100% right except the question is where you are starting from. Right now, the nominal Fed Funds Rate is only at 0.75%. But they’ve got this giant, bloated balance sheet. So what if you factor that into the equation? Former Fed chairman Bernanke and Bill Dudley at the New York Fed said that every six to ten billion dollars of excess reserves equates to one basis point of Funds Rate reduction. So you’re actually talking about a Fed Fund Rate at around -1.75%. That means if we are going to get inflation the Fed has a long way to go and it has to start jacking up interest rates really hard – and that’s where it could be very disruptive for the markets.

The next FOMC decision is on March 15. Will Fed chief Janet Yellen raise interest for the second time in only three months?
According to the futures markets, we started this week at a 40% probability of a rate hike. Now, we’re all of a sudden at 70 to 80%. So there has been a dramatic shift in the market’s thinking which is highly unusual.  A lot of that move is due to Dudley saying that the argument for a rate hike is compelling. The minutes after he said that the odds for a rate hike went up dramatically. Interestingly, in the last ten years there have been only two FOMC meetings where inside of twenty days to the meeting the market has changed its opinion on what the Fed is going to do. One of them was on September 16. 2008, the day after Lehman went belly up. Also, in such close calls the Fed always tipped to the dovish option to either not raise rates or ease because they’re concerned that if they upset the market it’s going to be all their fault. Now, we’ve got debate and confusion: Will they break with tradition and hike rates? If they do it is significant because they’re actually changing their approach.

What will Trump do with respect to upcoming appointments to the Fed?
There’s a total of seven governors at the Federal Reserve and today there are two vacancies. Soon there will be another vacancy since governor Daniel Tarullo announced that he wants to leave the Fed by April. Additionally, governor Lael Brainard might want to leave, too. And then Yellen’s term is up for renewal next February. Trump has already said that he will replace her. Now here’s the question: If you want to bring people back to work and create all these manufacturing jobs wouldn’t an easier Fed be to your advantage? Probably yes, but I take Trump on his word. He made it very clear. He said he’s going to get rid of Yellen so I’m going to operate under this assumption. That’s why I suspect that in one year to eighteen months we are going to have a new Fed chairman and we’re going to have three or four of the seven Fed governors appointed by Trump.

Who do you think Trump will pick as next Fed chair?
For the first eighty years after the creation of the Federal Reserve the governors and chairmen were mostly bankers, lawyers and other business people. But since 25 years that has changed. Now, they are mostly economists. So that’s a fairly new phenomenon and I think Trump will go back to bankers, lawyers and business people. He will choose people that have been successful in the private sector and not in writing papers at the economics departments of Harvard, MIT or Princeton. With this in mind, a possible candidate could be a guy like John Allison of BB&T or David Nason of GE Capital. Another name we hear is Kevin Warsh who has worked at Morgan Stanley (MS 46.83 1.19%) and was a Fed governor and is now at the Hoover Institute at Stanford University.

What does that mean for monetary policy?
All of these guys have in common that they think extreme monetary policies like QE and negative interest rates are counterproductive: They’re distorting the markets and don’t help the economy. They don’t create jobs. So what Trump’s picks will be doing is raising interest rates and reducing balance sheets. Based on their private sector experience they think that when we stop distorting the markets things will return to normal and we will have faster growth. That will be their argument. They won’t care about all those models with all those math equations which the Fed is operating on now. So you are going to have a very different Fed with a whole different mindset to it.

So how should investors position themselves in today’s markets?
As mentioned, I believe in the reflation trade and that we’re going to see inflation. That’s why I think that the ten year treasury note could move from 2.5% to north of 3% by the spring of next year. But that’s also the most consensus thing somebody could say right now. Everybody believes that interest rates are going to go up and everybody is betting on that. So when I look at it from my perspective as a former technical analyst I see such an overcrowded trade and I see so many people being short the bond market that I’m going to say that at first, we are going down to 2% by the middle of the year. And then, when inflation kicks in, we are going to 3%.

And what’s your outlook for stocks?
I think the stock market will continue to advance from here through the summer because we don’t have inflation and we have this hope about Trump getting the economy going. But then, as interest rates start going up, we are going to see the stock market struggle and these are going to be the early signs that the deflation-inflation mindset is starting to shift.


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VWAndy's picture

 It only took him 100 and 4 years to figure that out. Sharp guy. lol

gatorengineer's picture

You are kind we have been printing hard for 8, and stagflating hard for at least 4.....

I will still bet on Delfation as being the cause of the next crash not inflation (specifically housing price crash 2.0)....

HalEPeno's picture

I agree.  How can you have inflation w/o pricing power.  If the cost of food increases, people will buy less "goodies".  Health Insurance goes up even more..then fewer will buy insurance. Interest rates are secondary.  The Fed will be fighting a losing battle over deflation untilthe system crashes and resets.

FireBrander's picture

Local grocery store is offering $13hr to stock shelves; this in a city where the median HOUSEHOLD income is ~$50k/year...same job last year was being advertised for $9hr.

Burger joints are all at $9~$10hr.

Definately seeing wage inflation, but it isn't showing in prices yet; except for restuarants...but we rarely eat out anymore...crappy food and high prices isn't much of a draw.

DownWithYogaPants's picture

There are missing trillions at the pentagon.  Using that as a yardstick one might surmise there are other stashes of cash from the corrupt class.  Perhaps if inflation kicks in the corrupt class will start buying assets and drive everything up with their hidden do-rey-me.

Life of Illusion's picture

They’re distorting the markets and don’t help the economy. They don’t create jobs. So what Trump’s picks will be doing is raising interest rates and reducing balance sheets. 


If Trump pulls the QE plug 2nd year it will take 2 years to drain toxic debt,,,,,,economy tanks

I say toxic debt stays and Trump plans USA growth with or without war

No way he wants 1 term



Killdo's picture

just to make you happier about eating home-cooked food : 

I used to work as a comie chef for a Michelline stared chef. His right-hand assistent used to pick up steak poivre from the floor and put it back on the plate (just for shits and giggles) - actually normally if guests complaied. 

this was a good restaurant Sting, Annie Lennox, Phil Collins etc used to come to

BigFatUglyBubble's picture

How big of a crash in prices for housing would you estimate, and when?

flaminratzazz's picture

It will crash down in early 2018 to the point that a side of beef will be selling for a handful of .22 shells.

Housing made of wood will only be worth the BTU factor.

stone and brick will be sought after for the bullet proof advantage.

think caves..caves are good..

learn to eat raw liver..who gives a ratzazz where it came from..

The rabbi sells it on the corner..for .22 shells

Bananamerican's picture

the Delfations: sounds like a really smooth 70's R&B combo

DownWithYogaPants's picture

Doot doot da doo ewe

It's just my invagination 

woo woo

QuantumEasing's picture

"Is" going to be?

Whatta maroon.

SilverRoofer's picture


DUMB (____O____)

Xamune's picture

My sentiments exactly.

"I think the stock market will continue to advance from here through the summer because we don’t have inflation.."

What the hell are you buying and where the hell do you shop?!

bardot63's picture

Dow and S&P are always the first harbingers of inflation.  Trillions of debt are parked in that market.  It will have to go somewhere. 

ejmoosa's picture

The bubbles will only start to really burst when some folks start losing their jobs.

It could be from automation, or just layoffs, but it is coming.

gregga777's picture

You mean not having ~96,000,000 working aged Americans in the workforce isn't enough unemployment? There has to be more unemployment?

The real unemployment rate is somewhere between 23% and 40%.

Lost in translation's picture

The following are all of the imbecilic cliches used by assorted morons at all of the official/public functions, at my workplace:

"Game changer!"

"A sea change!"


There is precious little in the vocabulary of our falsely so-called "leadership," than the above ^

rockstone's picture

Jeez...wow. Fuck. That might be a problem.......

thefinn's picture

This just in from Obama


"This is the first I'm hearing of this problem."

"So, just like all the other problems then?"


TheVoicesInYourHead's picture

But ol'yellen says inflation is only 1.7%.

I guess that means that the doubling of housing costs, health care costs, and education costs, over the last few years are just a figment of our silly imaginations?

gregga777's picture

Inflation statistics are just more lies promulgated by the criminals at the Goldman Sachs Feral Reserve System.

The sole job of lying criminals like Alan Greenspan, Benjamin Shalom Bernanke, Janet Yellen, etc., are making the rich richer by stealing from those least able to afford and giving to those who least deserve it.

Last of the Middle Class's picture

The snake that is the FED swallowed a 10 trillion dollar cow 8 years ago. The anus that is the working man is about to get stretched to the limit as it turns into one HUGE inflation turd. Everybody knew this was going to happen. They were all just hoping not on my shift.

gregga777's picture

Bianca is just another CON Street swindlers who thinks that he has a crystal ball.

gregga777's picture

The stock market continues rising because the criminals at the Goldman Sachs Feral Reserve System are the biggest buyer of Stawks in the world. If they ever quit buying the rigged 'market' will crater.

debtor of last resort's picture

The dollar is your currency and will soon become your problem too.

hairball48's picture

First there will be a huge deflation in "paper" financials-stocks and bonds.

That will be followed by price inflation of "real" goods and services.

All this while there are riots among the peons




Don Sunset's picture

Inflation is rampant.  That's why growth is a joke with all this stimulus ($1T deficits annually).  However, inflation is building more and more.  It will subdue growth further.  It doesn't matter what the FED says.  The proof is evident.  The FED is so far in the corner now they have become irrelevant.  Growth is going to die no matter.  End game is closer.

Killdo's picture

Last year I spent 11 months travelling aroudn the world. When I came back to San Francisco - everything was about 20-30% more expensive. Also I have noticed the amount of food has shrank (and package stays the same). The 'no-inflation' story is a myth - like the official unemployment figure

You Only Live Twice's picture

Inflation is not entirely showing because of the Petrodollar System. However, with Oil hanging low, demand for USDs will decrease gradually over time, and the debt necessary to get them to purchase Oil will be sold and return to the Continental US. That is when inflation will grow, and the Fed's decision to hike rates while data is not there is demonstrative of this problem that is presently forming.

CTG_Sweden's picture




Jim Bianco does not say why the US inflation will pick up.

If the Fed will raise interest rates somewhat that means an appreciating USD which in turn will make imports less expensive which in turn will reduce inflation. But if Trump will manage to raise tariffs I guess that imports may become more expensive despite an appreciating USD.

Furthermore, it will take some time before consumer demand will pick up even if Trump will be as successful as he said before the election concerning the job creation. Poor consumer demand means less risk for inflation.

The principal reason why stock prices should go down is that stock prices have risen too much already. That´s the best argument I can think of. Anyone who disagrees? And why?



Sudden Debt's picture

America has no idea what's comming. only older people in Europe know.


artichoke's picture

The same older people who let Muslims flood their continent?


Going by that, they don't seem too bright to me.

ipso_facto's picture

Socialist is as Socialist does.

directaction's picture

In the '60s, gold was $35/oz.

In the '70s gold went past $100 and now it's  $1,250/oz.

Ya say inflation is coming? 

nathan1234's picture

Hey. Jim

You have forgotten about the over $200 trillion worldwide debt that can never be repaid.

When one cannot pay back their debt presently how can one pay more interest unless more QE and more loans to keep the Greatest Ever Ponzi scheme in the history of Mankind going?



Misty 34's picture

A definite "maybe" , without question. So enlightening .  I'm all set now.   (Such bullshit)  He must have a

side job as a "prof. at the nearest MBA mill.