Deutsche: The Fed Now Appears Powerless To Stop This "Unprecedented Bubble"

Has the Fed lost control of the market?

This question, first posed by Goldman last May, has received growing prominence in recent months, culminating with none other than Bill Dudley earlier this month, who pointed out the paradox of 5 consecutive rate hikes resulting in record easy financial conditions in his January 11, 2018 speech, one of his last as NY Fed Chair.

But if the Fed has indeed lost control of the market, that would mean that there is nothing the Fed can do until the market bubble bursts once the current melt-up finally rolls over?

That is quandary analyzed by Deutsche Bank in a recent report in which the bank observes that "an unprecedented bubble emerged during 2004-2006 when the Fed hiked rates 425bp" (as shown in the 3 charts below) and warns that "the current market environment is similar, in which monetary policy (hiking the policy rate) is likely to have a limited effect in restraining risk-taking."

Deutsche then lays out the three possible scenarios that could - in theory - stop, and maybe even reverse, the current asset bubble which are as follows:

  1. Monetary policies or communications designed to increase volatility,
  2. Monetary policies designed to hike long-term interest rates, and strangely
  3. Regulations and supervisions to curb  cryptocurrency trading.


And some further thoughts on these three points.

  1. First, Deutsche notes that former Fed Governor Jeremy Stein advocated for a monetary policy to cope with credit spreads (see excerpts below), but little headway was made in discussing policies targeting volatility (however, Chairman Powell prefers a communication style that raises uncertainty of monetary policy.
  2. Second, monetary policies designed to hike long-term interest rates include tapering quantitative easing, reducing the size of the central bank’s balance sheet, twist operations, and changes to yield curve control. Yet, these policies are all predicated on inflation accelerating.
  3. Which leaves option three: regulating cryptocurrency trading and initial coin offerings (ICOs) which however, unlike in China, will take time in developed countries.

And yes, the irony of the Fed trying to burst one bubble, that of cryptos, to keep the equity bubble going just a little bit longer, is hardly lost on anyone, although we are surprise by Deutsche Bank's skepticism that this approach could work.

In summary, the biggest German lender comes to the gloomy conclusion that:

"...monetary policy and regulations/ oversight could, like in the last financial crisis, come too late to prevent an expansion of the asset bubble."

In other words, in the worst case scenario - which appears to be DB's base case - not only has the Fed lost control, but it is now too late to hope for central bank intervention and reversing, or even halting the asset bubble, which will therefore grow at an ever accelerating pace, until it finally bursts in spectacular fashion.

Appendix:

Here are the Jeremy Stein speech excerpts, FOMC Minutes and Gov Powell quotes referenced above, on the interplay of Volatility and Monetary Policy.

28 February 2014, FRB, “There is no general separation principle for monetary policy and financial stability. Monetary policy is fundamentally in the business of altering risk premiums such as term premiums and credit spreads. So monetary policymakers cannot wash their hands of what happens when these spreads revert sharply. If these abrupt reversions also turn out to have nontrivial economic consequences, then they are clearly of potential relevance to policymakers.”, “In the absence of a general separation principle, when one might consider addressing financial stability issues either with regulation or with monetary policy, it becomes all the more critical to get the case-by-case analysis right that is, to really dig into the microeconomic details of the presumed market failure and to ask when a regulatory intervention is comparatively more efficient than a monetary one, or vice versa” 18 June 2014, FRB, Chair, Yellen, “To the extent that low levels of volatility may induce risk-taking behavior that, for example, entails excessive buildup in leverage or maturity extension, things that can pose risks to financial stability later on, that is a concern to me and to the Committee.”

5 July 2017 released, Minutes of FOMC (held in 13-14 June), “In the assessment of a few participants, equity prices were high when judged against standard valuation measures.”, “A few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.”

7 January 2017, FRB, Governor, Powell, “The current extended period of very low nominal rates calls for a high degree of vigilance against the buildup of risks to the stability of the financial system.”, “It would be very healthy to change the focus away from the median dots (which would not hit finally).”, “We can talk

Comments

lincolnsteffens Timmay Thu, 01/25/2018 - 18:58 Permalink

The Fed enables the bubbles and then sits back and waits for the collapse.

If you think for one minute that the Fed is working for the masses you need to take reality drugs. They are there to help their member banks and themselves make a shit load of cash leaving you with ever more declining purchasing power Federal Reserve notes plus higher taxes. This is all aided and abetted by the gov.

 

In reply to by Timmay

earleflorida kw2012 Thu, 01/25/2018 - 18:35 Permalink

one $trillion$ ?

who are we paying the bulk of the interest to?

the FRB System is privately owned by foreigners of private banks, or a cabal of mostly Zionist`jews. Period!

they only care about money -- aka. 'moneychangers', the only cabal that gets 'Compound Interest'! remember that?

the MIC gets on average per year ~ $$$ ONE TRILLION DOLLARS $$$ give or take a hundred billion :)

since 2003 (14 years) the USSA has been spending '1 Trillion $$$ annually (that's comes out to $14 Trillion that's divided by our taxes and the FRB via Treasury largesse) so let's guestimate the number at `$7 Trillion'... shall we.

Ref:  (read between the lines in what the author says and doesn't)                 simple title with easy answers-----      http://www.informationclearinghouse.info/48644.htm

 

In reply to by kw2012

YUNOSELL Thu, 01/25/2018 - 15:47 Permalink

The FED may be powerless to stop the tide from turning, but they are going to give it their best try and destroy the economy in the process

wmbz Thu, 01/25/2018 - 16:00 Permalink

Bubble? What bubble?

This is the new norm, you (Douche Bank) just don't understand it because you keep looking back for comparison. The greatest minds in the world have it all figured out this time.

The experts are on the J-O-B. We have finally reached that well deserved point in time where the stawk market only goes up, there is no limit. Just expand your mind and you will see it and embrace it.  

Ain't it great!

Jack Oliver Thu, 01/25/2018 - 16:04 Permalink

They have never addressed the FUCKING debt ! 

They never will ! 

The Zio/US know they can’t win ( after Syria ) or start a WW3 - Their allies are dropping like flies ! 

They won’t go quietly though - expect more chaos !! 

Roger Ramjet Thu, 01/25/2018 - 16:10 Permalink

Well hell, they could at least try!  They could start by beginning to draw down their balance sheet, like they said they were going to do starting last October.

It sure doesn't seem like they care at all, as it gives them an excuse for more QE and negative interest rate policy.

abgary1 Thu, 01/25/2018 - 16:23 Permalink

At least DB recognizes there are asset bubbles which is more than the Fed can say.

Central banks are still looking for inflation!?!?

Asset bubbles are inflation.

End the Fed!!!!!

khakuda Thu, 01/25/2018 - 16:26 Permalink

They always leave free money on the table to for too long.  This time, they have decided to leave it on the table forever to see if the ending is any better.

JibjeResearch Thu, 01/25/2018 - 16:38 Permalink

The interest rate can only go lower not higher, why?

Let say at 5% interest rate,

1. $1 trillion pay out to the debt holders

2. The bond market will be destroyed... and along with it... some pension systems, this one will cause a domino effect in the derivative market. 

3. if the US derivative market falls, the derivative of other nations falls too, and so does everything else.

https://www.investopedia.com/ask/answers/052715/how-big-derivatives-mar…