Smoke and mirrors

Recession and/or bust

With the world and his dog clamouring for the Fed to pivot because interest rates, because the bond market, because the dollar because, because, because the “Fed whisperer”, Nick Timiraos, rides to the rescue writing in the WSJ that the Fed is thinking of maybe doing less than 75bps in December. And lo the 10-year US Treasury yield swoons, the dollar goes smartly into reverse and the stock market takes the up elevator.

This will all help the White House cause, which is to improve their chances in the mid-term elections (although the observation that there are only two types of hope in a case such as this: Bob Hope and no hope, springs to mind) but there are other “initiatives” at work too, which have a very high chance of back firing. Biden is sorely miffed that the Saudis have cut oil production. His line of thinking being that the fist bump in Riyadh was the seal of approval to pump more not less.

He is now on a mission to crimp MBS’s style and is working with Congress on the NOPEC bill which would ban all oil dealings with OPEC countries on pain of confiscation of currency reserves held in the US, which in the Saudi’s cases is north of $1 trillion. The unintended consequences are very well spelled out by the writer of the Doomberg column (highly recommended - Doomberg | Substack )

“The most stunning move by the US and its allies was cutting off the Russian central bank’s access to most of its $630 billion of foreign reserves. Without access, one wonders if these funds are really ‘its’ reserves at all? What is ownership without access? No matter how justified that move might seem today, there’s no escaping that this action will reverberate for years to come….

“…This move substantially increases the risk that the US dollar loses its privileged status as the global reserve currency and, at a minimum, likely ensures a polarization of the global economy into at least two camps – the West in one and Russia/China/Iran/Saudi Arabia plus other targeted or aligned countries in the other. If $20-30 trillion or more of global GDP spurns the pre-existing reserve currency, is it still the reserve currency? If reserves can be negated overnight, are they even reserves? How many other countries must hedge against the possibility of similar sanctions?”

The “hedge” of course would be to sell down US Treasuries and other dollar-based assets, which Russia and China have been doing aggressively already. If the bill introduced before the mid-terms this selling might accelerate quite markedly.

One option that has been floated to contain US Treasury selling would be for the US Treasury itself to use its reserve fund – its surplus of cash raised from selling USTs to the market which hasn’t yet been absorbed by spending – to buy US Treasuries already in circulation:  quantitative easing by the back door. This would only be a temporary measure as the reserve fund will at some stage in the not-too-distant need topping up – by issuing more USTs!

In the short term i.e., pre-8th November (the date of the elections) such a move, plus a “pivoty pause” by the Fed, would send yields lower and along with it mortgage rates, would help the blue corner (Democrats are blue Republicans are red – back to front as usual in the US!). Biden is also threatening to further drain the strategic oil reserve in a bid to push down gasoline prices, another potential vote winner. As with so many of his actions it is debatable whether he can do this legally, but such a mere technicality hasn’t stopped him before.

If Powell gets called to the White House before 3rd November (the date of the next FOMC meeting to discuss rate rises) then the aforementioned “pivoty pause” rhetoric will be uttered, but that will do nothing for containing the inflationary impulse now under way. Whilst waning in some areas (goods and commodities), it is rising in others – services – driven mainly by wage growth. The only way to stop that is by delivering a recession which reduces labour’s bargaining power and leads to higher unemployment.

The obvious way to do that is to continue driving rates up, everything else is just smoke and mirrors.