Central Banks are in "zugzwang"

aka "they don't know what they are doing"

The ever prescient Luke Gromen - fftt-treerings.com -  has this to say about the dilemma central banks are facing.

Washington consensus seems to be that the Fed can create enough demand destruction (by raising rates aggressively) to get energy inflation down. US rig counts not rising despite near-record prices suggests an attempt to create energy demand destruction (by utilising aforesaid rate rises) will likely instead “destroy” US bond markets via credit risk well before said demand destruction drives energy prices meaningfully lower.

The flat rig count data seems to be the latest evidence of “Peak Cheap Energy”, and supportive of energy prices.

PS: Zugzwang is a German chess term referring to a position where a player has to move but every possible move puts the player in worse position than its current position.

He goes on to cite a scene in his favourite baseball movie as a metaphor for the current macro set up.

In this scene, rookie Archie Graham has just had two pitches thrown up at his chin after winking at the pitcher. Veteran “Shoeless” Joe Jackson calls timeout to give Graham some advice:

Shoeless Joe Jackson: The first two were high and tight, so where do you think the next one’s gonna be?

Archie Graham: Well, either low and away, or in my ear.

Shoeless Joe Jackson: He’s not gonna wanna load the bases, so look low and away… but watch out for in your ear.

We are quickly arriving at a key moment for markets: Will Powell “throw a pitch low and away” (back off on tightening as economic data weakens), or will Powell load the bases (trigger a global melt-down that sees stocks, bonds, and economies falling) and throw one “in our ear”?

We have high conviction the economic data is about to weaken, but low conviction in how the Fed will react or when. Markets seem to be taken by the idea that the Fed will raise rates by 50bps in both June and July and then take a breather. Bullard one of the more hawkish FOMC members is calling for at least another 250 bps between now and the end of the year. Even that might not cure the inflation issue, but it will throw one “in our ear”.

Powell was summoned to the White House to receive the wisdom of the President along with his supporting cast of Janet Yellen who was at least honest about her previous opinion on inflation, if doing little for her credibility.

I was wrong then about the path that inflation would take. As I mentioned, there have been unanticipated and large shocks to the economy that I, at the time, didn’t fully understand.

The Presidents credibility is not up for debate.

“I’m not going to interfere with their critically important work,” Biden said in remarks to reporters at the start of the meeting. “They have a laser focus on addressing inflation, just like I am.”

So, what happened at the meeting we wonder?

The chart above shows UST and Agency share of big US banks’ total assets is at a 40+ year record 27%.

The biggest marginal buyer of the UST and US mortgage market (the Fed) is no longer buying but turning seller.

The next biggest marginal buyer has been big US banks and they are already chock full of USTs and Agency MBS.

With that as background, what are the odds that the Fed, Treasury and White House just agreed on Tuesday to throw a pitch “in our ear” and tighten policy into a slowdown?

JP Morgan, Wells Fargo and Goldman Sachs all came out with similar rhetoric on the day after the meeting (having been briefed?)– “we’ll buy more USTs but not at these rates.

The chicken and egg conundrum is whether the Fed will raise rates regardless – “one in the ear” – or will Powell “throw a pitch low and away” i.e. back off on tightening as economic data weakens.

The key data point is inflation. If it continues to gather pace, then we will get one in the ear but if, as we are beginning to see, the rate of change slows (inflation won’t be disappearing completely any time soon if ever) then we could well see at least a pause in monetary tightening and bond markets will breathe a huge sigh of relief along with fans of the barbarous relic.

Mind your eye out there, and, of course, your ear!