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September 6, 2022

 People tend to hear what they want to hear and believe what they need to believe. In no place is this more true than on Wall Street. The Fed has made abundantly clear that it will tighten monetary policy until inflation is virtually vanquished. And yet, those who have no choice but to be nearly fully invested at all times have completely ignored this fact and were left trying to convince the investing public not to believe their own ears. That was a huge mistake going into the start of this year, and that is even more true today. The entire FOMC is promising that rates are going to increase to about 4% by early 2023, but the cheerleaders still say they are bluffing.

What is closer to the truth is that the Fed will continue to raise interest rates towards its 4% target unless the credit and labor markets collapse. The entire cohort of money printers and market manipulators have been thoroughly embarrassed by their transitory inflation prediction. And now, they care much more about the unaffordability of rents than they do about making sure corporate profits are better than expected. If they were to flip-flop again now, the little credibility they have left would be gone. Let me be clear, Powell will indeed eventually pivot, but it will be because the economy and equity markets have collapsed, not because stock prices are falling.

Investors should not take much solace in the idea that inflation has peaked because it always does during recessions.

The narrative from Wall Street is that inflation has peaked, the bear market is over, and a new bull market has begun. This sophomoric and specious conclusion completely ignores the other half of the equation, which is, the falling rate of change in CPI is a direct consequence of a faltering economy.

Hence, there is indeed a realistic hope that the Fed can stop hiking rates by 75 bps increments and can dial it back to 50 and 25 bases point hikes for the remainder of this tightening cycle. Powell may also stop raising the Fed Funds Rate altogether by early next year. However, it will come at the expense of a spiking unemployment rate, a crashing housing market, clogged credit markets, plunging earnings growth, and equity markets that are in complete chaos.

The bad news for the perm-bulls doesn’t end there. Powell will be very reluctant to lower interest rates after the 4% target rate has been achieved, regardless of the damage done to the economy. This is because the memory of a dangerous and embarrassing battle with intractably-high inflation has been seared into the frontal lobes of all the members of the FOMC.

Proof that a peak Fed Funds Rates, peak inflation, and peak interest rates aren’t always a green light for equities can be found in the data. Below are the figures from the BLS regarding year-over-year increases in CPI from 1999 thru the end of 2009. You can clearly see that during the collapse of the NASDAQ bubble, the cyclical peak of inflation was at 3.8% in March of 2000. Likewise, during the Global Financial Crisis CPI peaked at 5.5% in July of 2008.

Peak Fed Funds Rate and Peak Treasury Yields

During the Dot.com recession, the Fed started slashing rates in May of 2000 and had to reduce borrowing costs by 475 bps before the market bottomed—that process took two years. During the Global Financial Crisis, the Fed began its easing cycle in September of 2007 and eventually took rates down by 525 bps before stocks found support—that process took a year and a half and was aided by a massive Quantitative Easing program. In similar fashion, the 10-Year U.S. Treasury topped out in May of 2000 at 6.5%, and interest rates didn’t reach their cyclical bottom until June of 2003 at 3.1%. Likewise, the Benchmark U.S. Treasury Note topped out at 5.1% in July of 2007 and didn’t find a solid base until December of 2008 at just over 2%.

In both bear markets of 2000 and 2008, the S&P 500 shed about 50% of its value after the start of the Fed’s easing cycle began. Peaks in inflation, the Fed Funds Rate, and Treasury yields are not always a signal to buy stocks.

The key takeaway here is thus: Peak inflation also signals the peak in stock prices when the decrease in the rate of inflation is caused by a sharp decline in economic growth.

Peak inflation and lower borrowing costs are great news for equities in the medium and longer term. Nevertheless, buying stocks into the teeth of a recession is a really bad idea.

Stock valuations are still extremely high–P.E. ratios are higher than their 20-year averages, and earnings estimates are way too optimistic given the downward trajectory of global GDP growth. The Fed is hiking rates at the fastest Rate of Change in history, from 0% in March to at least 3.3% by the end of 2022. Meanwhile, Q.T. is now ramping up to $95 billion per month. Those negative effects on earnings and the economy have yet to be felt but will become clearly manifest in the near future.

It is crucial to have a model that is able to identify when easing financial conditions have sufficiently re-liquified the financial system and can lead to a viable bull market. In contrast, we are heading in the exact opposite direction today.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

 August 22, 2022

Despite all the fanfare and cheerleading you hear in the Main Stream Financial Media, the recent bounce in equity prices has just been a rather pedestrian bear market rally. Bull markets are not engendered by a faltering global economy, very high rates of inflation, and the most hawkish global central bank tightening cycle in history. Despite these dynamics, stock prices have now completely priced in a perfectly soft landing for the US economy. How else would you characterize trading at 17.5 times the 2023 S&P 500 ebullient earnings estimate of $245, according to FactSet? Keep in mind the $6 trillion of helicopter money ended in 2021, and earnings growth for Q2 2022 is negative 4%, excluding the energy sector. However, Wall Street is still projecting an increase of 50% for 2023 EPS from the pre-Covid level.

Nevertheless, the consumer still faces a barrage of negative shocks: A reverse wealth effect from falling equity and bond prices. The virtual complete shutdown of cash-out refinancing and the lower mortgage payments that come with it, which are down over 80% year over year. Anemic GDP and Earnings growth. Falling real incomes. And in addition to all this, we still have to deal with aggressive fed rate hikes and a double-dosed pace of QT.

Wall Street is trying to convince you that peak inflation will lead to a Powell Pivot towards dovishness. A dovish fed is one that is cutting rates back to zero percent and engaging in QE. But, peak inflation, which will still be 3-4 times higher than the target rate, should only cause the fed to reduce its hiking pace to 50 basis-point increments from 75 bps. In this age of redefining the meaning of recessions and bear markets, a dovish central banker is now defined as one that wants to raise rates by “only” 50bp increments.

Meanwhile, $95 billion of base money supply will get destroyed each month starting in September. This will happen in the context of a falling stock market, housing prices rolling over, and a potential spike in the unemployment rate. And, for those who still have a job, real incomes that continue to fall.

Lower bond yields and peaking inflation was a greenlight for higher stock prices in July. But that ebullience over an improving inflation rate should soon just become another signal of faltering economic growth.

Real Estate Prices to Follow Stock Prices Lower

The National Association of Realtors’ housing-affordability index, which factors in home prices, mortgage rates, and family income, fell to 98.5 in June. That is the lowest level of affordability in the past 33 years. Mortgage costs are up 54% y/y in June. And the median existing home price is $423k this June. It was just $94k 33 years ago. But what else would you expect when you have unelected money printing maniacs in control of the money supply? In other words, a house that does nothing but decay closer back to the dirt over the years has gained 350% in value. That rate of appreciation has been many times greater than incomes over the decades. The real estate market is dysfunctional and posing systemic risk once again. At 40% of core CPI, home price appreciation must be put back into a tractable situation for inflation to be tamed, and that will require a hawkish Fed for many months to come.

Evidence of a Faltering Economy

The US August Homebuilder Index fell to 49, which is now contraction territory–the estimate from economists was for a reading of 54. Housing starts fell by 9.6%, and single-family home construction dropped by 18.5% year over year.

We Have Seen This Movie Before

The last time the Fed hiked the Fed Funds Rates above 2.25% was September 27, 2018. It was also doing just $45 billion per month of Quantitative Tightening (QT) at the same time. That caused the S&P 500 to lose 20% and the Russell 2000 to lose 28% of their respective values by the end of the year. During this timeframe, GDP growth was 3%. The carnage in markets was so sharp that Fed Chair Powell had to promise to stop hiking rates by the end of December. But then again, he could afford to pivot easily back then because CPI was just 1.9%.

Today, much like the fall of 2018, the Effective Fed Funds Rate is 2.3% and is heading towards 3.3% by year’s end. But unlike the strong economy seen in 2018, GDP growth was negative in the first half of this year and is projected to be just 1.6% in Q3, according to the Atlanta Fed. Also, the pace of QT is more than double the rate it was back in 2018. In addition, the stock market is more expensive today and with more leverage in the economy than at any other time in history prior to the start of this year. And as for that much anticipated Powell Pivot, 8.5% consumer price inflation is a much bigger hurdle to overcome than any other time in the past forty years. Mr. Powell’s equity “Put” is way out of the money and far out of time.

Therefore, rather than getting caught up in chasing the FOMO rally, it is much smarter and beneficial to your financial health to get positioned for what is happening next: a global recession, which pushes money into US sovereign debt and the US dollar; and out of equities. That is, at least until Powell has the cover to perform a pivot back to QE and ZIRP, which will start to cause the dollar to tank and stagflation to run intractable.

Some perma-bulls liken today’s market to that of 1982. This was also a time when inflation had peaked. Back then, Fed Chair Paul Volcker was cutting rates from 15%, in March of ’82, to 8.5% by year’s end. The only salient similarity between 1982 and today is that inflation has peaked. However, the Fed is not cutting rates at this juncture. As stated, Powell is only slowing the pace of rate hikes from 75 bps to 50bps. And unlike 40 years ago, the Fed is also engaged in the most destructive pace of money destruction in history—more than a trillion dollars per year for the next 2-2.5 years. Most importantly, the PE ratio of the S&P 500 was just 7.7 back in 1982–not the overvalued 21.5 PE ratio we see today. Also, the total market cap of stocks as a percentage of the underlying economy was just 34% 40 years ago, not the frothy 170% we witness now. And, there is no Ronald Reagan in office cutting taxes and reducing regulations.

There is no time in history that compares with today’s record-high inflation and overvalued stock, fixed income, and real estate markets.

This dysfunctional and deformed market is prone to 30%, or even 50%+ plunges—as it has done in the past and is even more likely to do so in the future. Avoiding such a massacre in your retirement plans is a really good idea. Hence, successfully navigating these inflation/deflation cycles is the smartest way to invest.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

July 15, 2022

The reality of record-high inflation combined with a hawkish monetary policy is slowing the economy sharply and has led to the current U.S. recession—two back-to-back quarters of negative growth. The economic contraction should soon cause inflation to roll over along with bond yields, but that isn’t necessarily indicative of a new bull market. It is much the same process that occurred leading up to the Global Financial Crisis of 2008.

The major difference is that the level of inflation today is much greater than it was 15 years ago–a white-hot 9.1% for June of 2022, which is actually close to 20% if calculated using the same method back in 1980. That level is much greater than the 4.1% in December of 2007. Inflation may be peaking, but it is peaking at over 4.5x greater than the Fed’s target. Meaning, the FOMC will find it very difficult to give up its inflation fight anytime soon. It would be a different story if the Effective Fed Funds Rate was trading close to the Fed’s neutral range, which Mr. Powell believes is close to 2.5%, not the 1.58% seen today. With CPI at 9.1% and its balance sheet at $8.9 trillion, it is untenable for the Fed to remain stimulative to inflation. Indeed, the FOMC wants the interbank lending rate at 3.5-4.0% by the end of 2022.

Nevertheless, the apogee of CPI is probably here; and a falling 2^nd derivative of inflation would be great news for the stock market as long as it didn’t also come along with crashing economic growth. And, if the Fed were to slow down hiking rates, or even stop hiking completely, it would not necessarily be a panacea. During the last three recessions, the Fed had to significantly reduce interest rates and/or undergo Quantitative Easing programs to boost the market. Even after taking on such monetary endeavors, the results were not immediately manifest. During the Dot.com recession, the Fed had to reduce borrowing costs by 475 bps before the market bottomed—that process took nearly two years. During the GFC, the Fed took rates down by 525 bps before stocks found support—that process took a year and a half and was aided by a massive Q.E. program. And even during the outbreak of the COVID-19 pandemic, it took the start of unlimited Q.E. and a return to ZIRP before markets turned around. Newsflash for Wall Street: Monetary policy works with a rather long lag.

Can one honestly compare today’s situation with the debt levels and asset bubbles in existence leading up to the Tech and Real Estate bubbles? No, the current situation is actually much worse. See my commentary here for more data on our hyper-leveraged economy.

Peak Inflation? Maybe…but That’s Not the Issue

The intractable inflation seen in the June CPI print isn’t all about some aberrant spike in food and energy prices. Core CPI (ex food and energy) spiked 0.7% month over month, which is a faster rate than the previous month and was higher by 5.9% from the previous year. And, if you want to understand why consumer confidence is so dour, real hourly earnings decreased 3.6% year over year. In spite of this, a plunging growth rate of M2 money supply and the nascent destruction of the Fed’s balance sheet should send the rate of change of inflation lower in the months ahead.

But for now, extraordinarily-high inflation is undermining the economy, and evidence of the recession is all around us. For example, according to research firm Challenger Gray and Christmas, job cuts in the United States came in at 32,517 in June, rising by 57% on a monthly and by 59% on an annual basis. And, let us briefly visit the labor department’s fantasy island, a.k.a. the establishment jobs survey. June payrolls increased by 372k in the report. However, the ISM service and manufacturing surveys both showed these sectors actually lost jobs in June. Meanwhile, the all-important Household Survey showed that 315k jobs were actually lost. Also, the National Federation of Independent Business (NFIB) said its Small Business Optimism Index fell 3.6 points last month to 89.5, that is the lowest level since January 2013.

But back to the issue at hand, just because it may be true that inflation and bond yields are peaking, it does not sound the all-clear signal to buy stocks. The Benchmark 10-year U.S. Treasury Note topped out at 5.2% in July of 2007. The official start of the Great Financial Crisis was a few months later, in December of 2007. And the cyclical bottom in the Benchmark Treasury yield did not occur until the very end of 2008. If you had bought stocks in July of 2007 because the Fed was done tightening and the top of bond yields were in, you would have made a tragic mistake. Between July of 2007 (cyclical top in yields) and December of 2008 (cyclical bottom in yields) the S&P 500 shed 43%. This is because the high-water mark in bond yields not only signaled the top of year-over-year changes in the rate of inflation. But more importantly, it also signaled a dramatic steepening in the decline of economic growth and earnings.

While there is still more room to the upside for the Fed Funds Rate, long-term bond yields and inflation have most likely put in their cyclical high. Nevertheless, those conditions do not lead to an imminent bottom for the stock market. For that to occur, you will need the liquidity and credit conditions to improve significantly. Therefore, for the time being, it is best to still ignore those bottom pickers who continue to just end up with really smelly fingers.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

June 28, 2022

 President Joe Biden, Treasury Secretary Janet Yellen, the entirety of the money printers who inhabit the Federal Reserve, and virtually all of the deep state of Wall Street are still busy trying to convince you that a recession is unlikely. Well, here’s some news for all of them. Whether or not we will have a recession is no longer a question. The recession is already here. The only question is, how deep the recession will become.

The consumer is getting attacked on all fronts, and their consumption accounts for nearly 70% of GDP. Falling real wages, spiking debt service costs, plunging cryptocurrencies, sinking stock prices, and battered bond values are seriously injuring their financial health. And coming soon to a theater near you, a real estate wreck is in the offing. Instead of home prices rising 20% per annum as they have over the last couple of years, the pace of home price appreciation should soon decline sharply. Home affordability is at a record low, while new listings and price reductions are on the rise. Home equity extractions have been severely depressed due to rising mortgage rates. And now, depreciating real estate values shut down the bad consumer habit of relying on equity extraction to boost consumption.

The final blow to this consumption story will be the labor market. A rising number of US corporations are now placing hiring freezes and/or engaging in outright layoffs.

All this is exactly what the Fed wants and needs to occur to bring inflation back towards 2%. However, the Fed has an abysmal record of getting anything right—especially when it comes to inflation and its targeting. The Fed couldn’t get inflation to rise to its 2% target during most of the period between 2008-2020. Then, with the help of Treasury, managed to send inflation soaring past 2%. In fact, it went all way to 8.6% rather quickly with the launch of a massive helicopter money scheme in the wake of the COVID-19 outbreak.

And it is this intractable inflation that is preventing Mr. Powell from pivoting dovish anytime soon, despite a blatantly obvious recession staring him in the face. Sales of existing homes were 8.6% lower in May of this year compared to the same period in 2021. That is lowest reading since June of 2020, during the early stages of the pandemic-induced shutdowns. Can it really be possible to have an expanding economy when existing home sales are falling this sharply? In May, the seasonally adjusted annual rate of housing permits to build a home decreased 7% month over month. And, actual Housing starts fell 14.4% m/m. That fall in housing starts was the largest m/m decrease since April 2020.

The June Philadelphia-area Manufacturing Survey contracted by 3.3% vs. an expected gain of 5.5%. New orders in this survey plunged by 12.4 vs. a positive 22.1 last month. Does this sound like an economy that is growing? No, it does not. Q1 GDP posted a reading of -1.4%, and the Atlanta Fed GDP Now estimate for Q2 is 0.0%. This means the US economy shrank during the first six months of 2022. That is a recession by the technical definition or any other honest measurement of the economy.

It isn’t any wonder why consumer sentiment is at an all-time low. Despite this recession, the maestro of the Fed’s Gong Show stated at the June FOMC Press conference and also at his testimony before Congress that the US consumer and economy are very strong and can withstand the most hawkish monetary policy in history. Perhaps Powell should try his luck at stand-up comedy.

Instead of the cheerleading, you’ll find in the Main Stream Financial Media, I’ll offer the top two reasons why this bear market is much worse than any bear market since homo-sapiens began roaming the earth.

1. Asset prices are falling, and the economy is shrinking at the same time, inflation is at a record high. This means for the first time in forever, the Fed is forced to hike rates into a recession. In fact, we have the most aggressive hiking cycle ever. Powell is raising the Fed Funds Rate by 75 basis point increments, while Quantitative Tightening is destroying $47.5b of money supply each month. That is, until September when it will then spike to $95 billion per month. Powell now states he wants the Fed Funds Rate at 3.25-3.5% by the end of ’22.
2. The second reason why this bear market will be epoch in nature, is that the total amount of outstanding debt is higher today than at any other time in history, both in nominal terms and in terms of GDP. At the end of last year, corporate debt had soared to $11.6 trillion, which is 48% of GDP and an all-time record high. And, Total Non-financial debt has skyrocketed to $65 trillion, which is another record high and an incredible 270% of GDP. What we have in reality is an 84% increase in corporate debt and a 94% jump in Total Non-financial Debt since the Great Recession! A greater amount of defaulting debt leads to a greater economic disruption.

Making matters even worse, it’s not only the US that finds itself in this dire situation. A plethora of the world’s major central banks are fighting much the same battles. Here is a list of countries that are in the process of raising borrowing costs: USA, Australia, Chile, South Korea, Brazil, Great Britain, Canada, Czech Republic, Hungary, Israel, India, Mexico, New Zealand, Norway, Poland, Saudi Arabia, South Africa, Sweden, Switzerland, and the Entire European Union is expected to join the parade this July.

Despite all the damage that has been done to the stock market, the valuation of equities as a percentage of the underlying annual production of the economy is higher today than at any other time in history prior to 2020. The total market cap of equities as a percentage of GDP is currently 155%. That is over ten percentage points higher than the peak of the NASDAQ bubble in 2000 and over 50 percentage points higher than it was going into the start of the Great Recession in December of 2007. As a reminder, the NASDAQ lost 80% of its value between 2000-2002, and the S&P 500 shed 57% from October of 2007 to March 2009. In other words, the bottom pickers should continue to end up with very smelly fingers until inflation is vanquished and the recession is fully priced into stocks.

Then, a new bull market should arise, but it will be marred with the stench of stagflation all over it. Meaning, the buy-and-hold, 60/40 portfolio died a long time ago and won’t be resurrected anytime soon. The inflation/deflation dynamic is growing more intense with each boom/bust cycle, and that requires a different approach to investing than what is offered by most Wall Street firms.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

May 27, 2022

Bear market bounces are violent yet short-lived. The latest excuse for an oversold rally was provided by JP Morgan’s Jamie Dimon. The bank’s CEO stated at Morgan’s Investor Day Conference on Monday, May 23^rd, that the US economy remains strong despite gathering storm clouds. He said, “I’m calling it storm clouds because they’re storm clouds. They may dissipate.” This was indicative of the typical vapid speech of the optimistic bank CEO. While he was at it, he also raised the bank’s outlook for Net Interest Margin at the bank’s conference, causing the usual parade of Dimon groupies to celebrate with orgasmic delight about his confidence in the economy.

Perhaps Dimon is compelled to do his impression of PT Barnum because shares of JPM have lost 30% of their value so far this year. But before you believe Dimon is some economic oracle, listen to what he predicted about US economic growth on Jan. 11^th when he publicly proclaimed his 2022 outlook, “We’re going to have the best growth year we’ve ever had this year, I think, since maybe sometime after the Great Depression.” He said this during a quarter that would later show to have shrunk at a 1.4% annualized rate. And that bad economic data didn’t cease at the end of Q1. S&P Global US Composite PMI Output, which tracks the manufacturing and services sectors, fell to a reading of 53.8 in May, from a 56.0 reading in April, which means the economy is fast approaching contraction territory in Q2. A slew of manufacturing PMIs also supports the view that the US and, indeed the entire global economy is faltering. The plunging numbers on home purchases and refinancing activity indicate danger is ahead. Nevertheless, despite a parade of sharply declining economic data, the financial media is promoting the view of Wall Street analysts that earnings growth is actually going to be robust this year and next.

This is one reason why the bottom of the bear market isn’t yet in sight. In fact, if the stock market were to return to a more normal valuation, one where the total market cap of equities was equal to annual total output of the economy, it would have to decline by 37% from the current level. But bear markets seldom, if ever, just decline to fair valuations; they usually slice through that level and find support once the market displays a broad array of metrics that indicate it is undervalued. So, despite a brutal bear market, the grand reconciliation of asset prices should continue on.

How brutal has it been? Ycharts calculated the percent declines from all-time highs of some widely held stocks at the end of last week.

As bad as this has been, it is more indicative of how overvalued the market had become rather than being a sign of an imminent bottom.

Vanda research recently reported that the average retail portfolio is down 32% this year. And this bloodbath isn’t limited to stocks. The flagship crypto (BTC) is down 55% since November of last year, long-duration Treasuries are down 20% YTD, and the housing bubble is the next in the queue to implode.

The bear market should continue until a sufficient amount of disinflation is manifest, which can then give Chair Powell the economic and political cover to turn dovish. But this probably won’t occur until around September or October.

There is still a lot of damage that can be done between now and then. Of course, what exactly the Fed will do and how it will affect the market is too early to determine at this juncture. But investors should not expect the “Fed Put” anytime soon just because the economy is rapidly decelerating. The Fed now blames the weakening economy precisely because of inflation that ran too far away from its 2% target. Hence, getting inflation back toward 2% is Powell’s number one priority—that is, unless the credit markets stop functioning. However, another round of Universal Basic Income and QE, which may be deployed once again if the credit markets meltdown, will occur while the wounds of record-high inflation have not even begun to heal. That could end up being devastating for our currency and debt markets. In other words, there is no pain-free path for the Fed to take. Turning dovish may not send all asset prices soaring as it has done in the past because intractable stagflation is the salient risk and indeed the most likely outcome—and that isn’t good for most stocks.

Powell should have resigned a long time ago.

In response to the upcoming recession, expect the Fed, Treasury, and D.C. to coordinate the monetization of trillions upon trillions in helicopter money. But think twice if you believe that will fix everything. Just imagine the consequences of turning back towards a massive inflationary policy while the sting of destabilizing inflation is still raw in the minds of consumers and investors. The US now has record-high inflation while also enjoying a tremendous dollar bull market over the past year. But just imagine how destructive that inflation will become once the Fed’s balance sheet vaults over $10 trillion and then quickly races towards 100% of GDP; with no end in sight. And, at the same time, the dollar crashes–not only against goods and services like what is happening now, but against our major trading partners–causing import prices to surge.

In conclusion, the bear market has many innings to go, the Fed pivot is still months away, and that turn towards a more dovish policy isn’t going to solve all the economic and market problems. Indeed, it will make them much worse. This is why the buying and holding of a typical 60/40 portfolio no longer works. And why an Inflation/Deflation investment strategy is growing more crucial to successful investing with each boom/bust cycle.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

May 20, 2022

Wall Street, we have a margin problem. Shares of Target (TGT) fell by 25% on Wednesday the 18th as their margins shrank by the same amount. TGT margins collapsed due to higher input costs, overstocking, and overstaffing. So much for the mantra that stocks are a great hedge against inflation. In reality, inflation is destroying American corporations, the economy, and the middle class.

Walmart (WMT) is America’s and the world’s largest private employer. Its earnings report on Tuesday the 17th had a lot to say about the US economy. The company missed earnings primarily because of inflation and margin pressure. One of the primary drivers for the margin compression was that WMT has TOO MANY EMPLOYEES. The reason is clear: after the COVID stimulus checks expired, these furloughed workers found themselves out of savings and in need of money. Hence, they returned to work en masse. The key point here is that the world’s largest employer is no longer hiring but instead will be letting workers go. There are over 2.7 million people employed by WMT and TGT.

A weakening labor market would normally get the Fed to turn dovish. However, Mr. Powell and the Fed cannot turn dovish imminently. Nevertheless, Wall Street is still hoping that the Fed put is nigh. But record-high inflation is the primary problem facing consumers and corporations. Chair Powell finally understands this. Therefore, the Fed has been forced to adopt the most aggressive tightening monetary policy since 1980. This is precisely because an economy cannot function properly while inflation is extremely high.

In spite of this, the Fed, along with its lackeys in MSFM, are busy trying to convince investors why this current tightening cycle won’t end in recession and a stock market meltdown like nearly every other time in history. They hasten to liken this tightening cycle to the one that ended in a soft landing in 1994. The Fed took interest rates from 3% at the start of 1994 up to 5.5% by the end of the year. That total of 250 bps of rate hikes did not cause a recession and is viewed as proof that the Fed’s ability to engineer a soft landing is readily achievable this time around. Indeed, GDP growth for all of 1994 came in at a solid 4%. So, will 2022 turn out like 1994, as the perma-bulls would have you believe?

The chances of a soft landing in the economy are near zero–this rate hiking cycle will be nothing like 1994.
Fed Chair Alan Greenspan started hiking rates by 25bps to 3.25% in February of that year. CPI averaged 2.6% during 1994, with a high print of 3%. Three percent inflation is not even close to the 8.3% inflation we suffer today. Also, the 10-2 Treasury yield curve spread was a healthy 150 bps in ’94, which is indicative of a healthy economy. In sharp contrast, the Fed started hiking rates this time around when that yield spread was flat to inverted. In addition, GDP growth was 3.9% in Q1 of 1994. Q1 GDP growth for 2022 actually started out with negative 1.4% annualized growth. Hence, the situation today is one where inflation is much higher, and the starting point of GDP is significantly lower than it was during that extremely rare soft landing enjoyed 28 years ago.

Most importantly, the Fed was only raising the Fed Funds rate in 1994 in order to bring down inflation. However, this rate hiking cycle is being paired with a Quantitative Tightening (QT) program that is nearly 2x greater than the previous failed attempt to reduce the Fed’s balance sheet back in 2018. Also, the asset bubbles and debt levels seen today dwarf what was in place several decades ago. As Guggenheim’s Scott Minerd points out, the fed has never reduced inflation by more than 2 percentage points without engendering a recession. Mr. Powell is now tasked with reducing inflation by over 6 percentage points. Soft landing, no. Crashlanding, yes.

A few recent and important data points need to be highlighted. Nonfarm productivity, a measure of output per unit hour of work, declined 7.5% during Q1. That means worker productivity fell to start 2022 at the fastest pace in nearly 75 years. At the same time, unit labor costs soared 11.6%, bringing the increase over the past year to 7.2%, the biggest gain in labor costs since Q3 of 1982. Productivity is how you grow a healthy economy, not by inflation. Mr. Powell, we have an inflation problem.
Hence, the Fed must continue with its very hawkish monetary policy stance until one or more of the following three things occur: back-to-back negative Non-farm Payroll reports; the credit markets freeze (no high yield, commercial paper, CLO etc. issuance) or inflation drops back below 4% on a y/y basis and the m/m increase drops below 0.3%. The latter is your only hope for a significant and sustainable market rally. If the job or credit markets falter first, the market will go into freefall before Powell has time to react. So, the bulls have to hope for inflation rates to drop precipitously within the next few months.

However, the May 11th release of April CPI data dampened the idea that inflation is going to significantly cool off anytime soon. In contrast, the m/m inflation rate is actually increasing. So, the markets and economy are in a race against the Fed. Inflation has to subside imminently–before the 50 bps rate hikes of June & July occur and the $95 billion per month QT program ramps up in September. The economy and markets are already sputtering, and this is before the Fed Funds Rate is above 1% and before QT begins on June 1st. Save the bottom fishing talk for the mainstream financial media.

This still nascent bear market will eventually set investors up for a great buying opportunity, but only after inflation becomes fully tractable. That great buying opportunity is reserved only for those who had the foresight to preserve their capital during this bear market (which includes raising extraordinary amounts of cash in the short term).

For most of Wall Street, who have bought and held the whole way down, there is only a painful crash landing in stocks and the economy with no chance of deploying a substantial hoard of cash once the bottom is in. Whereas investors with their capital intact will have a better chance to profit once this liquidity crisis is over.

Wall Street’s Inflation/Deflation, Boom/Bust cycles continue unabated. Progressively greater doses of helicopter money and debt monetization should ensure these cycles will continue to grow more dangerous with each iteration. That is really bad news for most investors. But for those who know how to trade these dynamics, it may just provide more opportunities to shine.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”

April 14, 2022

 The economy is faltering, and markets are becoming chaotic. In spite of this, the mainstream financial media is busy convincing investors that the bull market is solidly intact.

The 10-2 Treasury yield curve inverted on Tuesday, March 29, 2022. This inversion has occurred for the first time since September 2019. Meanwhile, the 30-5-year Treasury yield spread has also inverted in late March, the first time such an inversion has occurred since 2006. Such inversions nearly always signal the economy has weakened sharply and is headed for a recession.

But right on cue, Wall Street apologists are data mining parts of the yield curve to try and explain why the economy is strong and that a recession isn’t in the cards. They try to deflect your attention away from the most salient 10-2 curve inversion and instead point to the 3-month, 10-year curve spread to dismiss the whole flattening and inversion thing going on everywhere else. Why? Well, because they always need an excuse to stay bullish.

Newsflash, the 10-3month Treasury yield spread is only temporarily lagging behind the more relevant parts of the curve simply because the Fed has long dithered to raise the Funds Rate. The fact is, the 3-month T-bill is always pegged very close to the FFR. And since the Effective Fed Funds Rate is still stuck at around .33%–again, that to Powell’s reticence to fight inflation– this part of the curve has yet to invert. However, once Mr. Powell really gets going with the tightening process, this part of the curve should invert too, as the overnight lending rate eclipses longer duration yields.

Allow me to briefly explain why all this curve inversion stuff is so important. It is all about money supply growth and the access to credit. You see, we have a debt-based monetary system. This means money is created when a bank makes a loan. Banks make a profit between what they pay to depositors (borrow short) and the income they receive from their assets (lend long). When the yield curve inverts, their profit motive is greatly eroded, just as the risk of making new loans increases. This dynamic occurs at the same time consumer’s demand for credit decreases due to their need to reduce leverage. The monetary liquidity then dries up, and asset prices begin to tumble.

Of course, Wall Street abounds with Pollyanna’s that come up with reasons for the investor lemmings to walk blindly off the cliff. Enter Deutsche Bank and its soothing words offered to us regarding the history of curve inversion. Their research indicates that after the 10’s-2’s inversion takes place, the market has peaked between 3-25 months later. And the average increase for the S&P 500 after that initial inversion is 19%.

Let’s take a look at the more relevant data that the Deep State of Wall Street so conveniently overlooked. We will first dismiss the last curve inversion that occurred in the late summer of 2019–just a few months before the economy and markets tanked–because of the assumption that the yield curve just got lucky due to the unpredictable COVID-19 pandemic.

So, let’s instead look at what happened during the time leading up to the Great Recession of December 2007 thru March 2009. The spread between the 10 and 2 Year Note first inverted on December 27^th 2005. The economy was so strong back then that the Fed was able to hike rates by 325 bps (from 1% to 4.25%) during the timeframe beginning with the first hike in 2004 until that first inversion occurring at the end of 2005. But after that initial curve inversion, the Fed was only able to push through another 100 bps in rate hikes before it had to stop tightening policy in June 2006. This pause was due to a clear deceleration of economic activity. Despite the Fed’s relaxation of its hawkish monetary policy stance, the economy continued to deteriorate, and the stock market topped out a year later in the summer of 2007. The Great Recession began just a few months later.

Today’s economic situation is very different. The economy is so weak right now that it only took one, 25 bp rate hike to invert the 10-2 yield spread. This leaves just about 100 bps of hiking that can be done before the economy slows enough to turn a hawkish central banker into a dove. The problem is, since inflation is at a 40-year high, Mr. Powell cannot easily turn dovish. In fact, he has scheduled another 225 bps of rate hikes this year alone. And, due to that 8.5% CPI, 11.2% PPI & 12.5% Import Price spike; he must continue with his rate hike campaign–in conjunction with QT—until inflation is under control or markets plunge…whichever comes first.

Another part of the recession cover-up story is the idea that leverage in the system has all but disappeared. Let’s compare the period of time just prior to the start of the Great Recession, which is regarded as the most overleveraged economy in U.S. history, to the state of the economy as of the latest reported data at the end of 2021. In December 2007, corporate debt was $6.3 trillion (42% of GDP). At the end of last year, corporate debt soared to $11.6 trillion (48% of GDP, which is a record high). And, Total Non-financial debt was $33.5 trillion (227% of GDP) at the start of the Great Recession. But now, Total Non-financial debt has skyrocketed to $65 trillion, which is an incredible 270% of GDP. What we have in reality is an 84% increase in corporate debt and a 94% jump in Total Non-financial Debt in just the last 14 years!

The major point here is the amount of debt has increased significantly in both nominal terms and as a percent of GDP after each recession. This means the level of interest rates it takes to break the economy keeps reducing. In the year 2000, it took a Fed Funds Rate of 6.5% before the market melted down. Leading up to the Great Financial Crisis of 2007-2009, that level dropped to 5.25%. Then, due to the massive leverage prompted by the Fed and Treasury following that crash, it then took a FFR of just 2.5% to cause the credit markets to freeze and stocks to falter in 2018. Today, it will probably take a FFR with just a one-percent handle before the financial markets once again meltdown.

Therefore, don’t be fooled. The economy is much closer to a contraction than Wall Street wants you to believe. The Fed’s tightening cycle is very far from routine this time around. Inflation isn’t just high; it’s at a 40-year high! This means Mr. Powell will not only be raising the Fed Funds Rate by 50 bp increments instead of the usual 25 bp hikes, but he will also be engaged in the monetary destruction mechanism known as Quantitative Tightening at the same time. Powell will be burning around $95 billion of the base money supply each month beginning around May, which is $45 billion more than what was done during the height of the last QT. Indeed, the March FOMC minutes show that the ramp-up to that level will only take three months, instead of the baby steps that were taken the last time the Fed tried to reduce its balance sheet.

The Fed is not now trying to slow down an economy that is overheating. In sharp contrast, GDP and earnings growth are now both rapidly slowing. An accurate recession indicator can still be found in an inverted yield curve. But that inversion usually occurs after the Fed has raised interest rates several hundred basis points over several years’ duration. However, this latest yield curve inversion has occurred after just one measly 25 bp rate hike. That is indicative of a very weak economy. The powerful inflation-fighting measures of monetary destruction (QT) and significant rate hikes still lie ahead. And that can only greatly exacerbate the current weakness; despite Wall Street’s best efforts to convince you otherwise.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

March 24, 2022

The recent stock market rally is a trap. This is because Wall Street is vastly underestimating how hawkish the Federal Reserve will have to get in order to fight inflation. And how much weaker earnings and GDP growth will become as a result. The fact is Mr. Powell has finally become enlightened to the inflation crisis engendered by his own hand. The Fed Chair’s inflation epiphany is mainly the result of his observation that shelter costs are soaring out of control. He now realizes that he will have to pop the housing bubble in order to vanquish inflation.

The data on this front is shocking. Home value growth was so extreme last year that it actually surpassed median salaries in 25 of 38 metropolitan areas across the country, according to research firm Zillow. And, rent prices have surged by nearly 20% Nationwide year over year in January, while in the sunbelt, they have skyrocketed by 50%! Some 30% of these properties are owned by Wall Street and other investors.

What else would you expect to occur when the Fed guarantees access to money for next to nothing. Wall Street then uses that cheap credit to purchase massive tracks of single-family homes with a cash deal and then rents them out to would-be first-time homebuyers that have been priced out of the market by this very process. Wall Street wins big, profiting from both the increase in real estate prices and the increased cash flow derived from rising rent payments. While the people the Fed professes to care the most about fall further behind the American dream.

Hence, that is why the Fed will now fight inflation aggressively…at least until the credit markets meltdown once again. We should see more evidence of an enlightened Powell in the May FOMC meeting and press conference, where he most likely will not only raise the Interbank Lending Rate by 50 bps, but most importantly, begin to destroy the base money supply as well. He will also, at that time, lay out his plan to aggressively increase the pace of such monetary destruction (QT).

Indeed, St. Louis Fed President James Bullard wanted a 50-basis point increase as a result of the March FOMC meeting and wants to take the Fed Funds Rate up to 3% this year. Joining Mr. Bullard is Fed Governor Christopher Waller and Cleveland President Loretta Mester, who recently stated that the central bank might need to enact one or more half-percentage-point rate hikes in the months ahead.

Despite the hawkish Fed and the uniqueness of this tightening cycle, the Perma-bull, Pollyanna’s on Wall Street, trotted out the data on what happens to stocks after the Fed first begins to hike rates. Spoiler alert, it’s usually good. The S&P 500 has returned an average 7.7% in the first year after the Fed begins to raise rates, according to a Deutsche Bank study of the past 13 hiking cycles. Of course, the lemmings bought Powell’s March rate hike with reckless abandon, believing that this cycle will be like the others.

In sharp contrast, the current tightening cycle will not be anything like the previous 13. This time around, the Fed is hiking rates because inflation is at a 40-year high as calculated under the CPI’s latest massaged methodology. But the fed knows that if calculated as it was in the ’70s, inflation is at an all-time high. So, this tightening cycle will be unusually aggressive. Also, the Fed normally hikes rates into an economy that is strong and getting stronger. However, the economy is now weak and getting weaker–Q4 2021 GDP growth was 6.9%, but Q1 GDP growth this year is projected to be just 1.3%. Last year, S&P 500 EPS growth was 47%; but EPS growth for the first half of ’22 is projected to be around 5%, which is wildly optimistic given all the current circumstances but still one of the most rapid decelerations in history.

While the stock market remains brainwashed by its own bullish B.S., the bond market isn’t nearly as delusional. The spread between the ten and two-year Note is under 20 bps. That is very close to an inversion, and an inversion nearly always presages a recession. History shows that when the yield spread is this tight, the Fed can only hike just two times before the yield curve pancakes and the economy and stock market poop the bed. This normally turns a hawkish Fed back into a Dove, but the big problem now is Powell can’t easily pivot this time around because of that pesky 7.9% CPI.

Not only this, but this tightening cycle will be one of the most aggressive tightening ever. Mr. Powell will be hiking rates at the same time he is draining the balance sheet at a record pace and quantity. Rate hikes in conjunction with QT had happened only once before and didn’t work out well for the bulls.

In October of 2017, the Fed began to very slowly drain its balance sheet and raise rates at the same time. And by slowly, I mean baby steps on both QT and rate hikes. The Fed started QT by allowing just $6b per month for Treasuries and $4b per month for mortgage-backed securities to roll off its balance sheet. The amount of balance sheet reduction was capped at $600 billion per year at the peak of QT in 2018. Also, the Fed hiked rates by just 50 bps throughout all of 2017.

By the fall of 2018, the stock market began to meltdown, and Powell promised to stop raising rates in December of that same year. However, he dared to continue to reduce the size of the balance sheet with disastrous results. Only a few months later (in March of ’19), he was forced to reduce the pace of QT. And by July of 2019, the Fed had no choice but to end QT altogether–a few months earlier than Powell indicated it would end–because the credit markets were in full meltdown mode.

This next QT program, which should begin in May, will not start with baby steps at all. It is promised by Powell to be much more aggressive at the start and is projected to quickly ramp up to remove around one trillion per annum from the money supply. The only other attempt at QT was able to reduce the balance sheet from $4.4 trillion to $3.7 trillion (a total of $700 billion) before utter chaos was unleashed. The Fed’s balance sheet is now $9 trillion today for comparison.

Therefore, this hiking cycle is totally incomparable to any other. And it will have an extremely negative effect on the record-high values seen in the equity market and real estate bubbles. There are times when investing in the market without any hedges at all is worth the risk. This is definitely not one of those occasions. Indeed, this bear-market bounce gives investors one last chance to prepare for what should be one of the worst market crashes in history. The time to get your portfolio on board the four horsemen of the economic apocalypse is probably just a couple of months away.

March 7^th, 2022

The U.S. economy is already deteriorating due to the humongous fiscal and monetary cliffs. These cliffs are now being compounded by the war in Eastern Europe and near record-high inflation. And, the Fed’s “PUT” is much lower and smaller in size than Wall Street believes.

The war in Ukraine will exacerbate the negative supply shocks that are already in place due to COVID-19. Worsening bottlenecks will combine with rising inflation to produce a contraction in global growth. Russia produces 12% of the world’s oil supply and exports 18% of the world’s wheat consumption. Ukraine accounts for 25% of global wheat production. Sanctions and war will serve to slow the economy further and send prices for these vital commodities even higher.

But the upcoming recession will be extraordinarily unique. Not only will it occur while inflation is at a multi-decade high, it will be the first U.S. economic contraction to take place while the Federal Reserve had its target interest rate at or near zero percent. For comparison, look at how much room the Fed had to reduce borrowing costs during previous economic contractions.

The following historical data indicates the level of the Fed Funds Rate just prior to the outset of all 10 U.S. recessions since WWII: 1957 3.5%, 1960 4.0%, 1969 10.5%, 1973 13.0%, 1979 16.01%, 1981 20.61%, 1989 10.71%, 2000 6.86%, 2007 5.31% and 2019 2.45%.

In addition, the swoon in GDP will occur after the Fed has just finished printing $4.5 trillion over the past two years and with the national debt vaulting over $30 trillion due to the massive increase in government deficits in the wake of the COVID-19 pandemic. Such borrowing helped send the government’s debt to GDP ratio soaring to 125%. For perspective, that ratio was just 53% back in 1960, and only 58% as recently as 2000.

Inflation is destroying real wages, and rising borrowing costs are destroying consumers’ ability to consume. Consumption is 70% of GDP, and that means the rate of economic growth is set to plunge. This would normally spur the government into remediative action. But the fact remains that the ability of the Treasury and Federal Reserve to turn around a recession expeditiously by borrowing trillions of dollars and having that debt monetized by the Fed has become greatly fettered this time around.

Mr. Powell is in a conundrum that is mostly of his own making; and from which there is no innocuous outcome. If the Fed gets overly concerned about slowing GDP due to the conflict in Ukraine, it could, for the most part, shelve its plans to raise rates and the planned reduction in the size of its balance sheet. But that would risk propelling inflation even further away from Powell’s stated 2% target, which he has exceeded by 3.75x. Inflation expectations could then rise intractably from there. In other words, doing nothing isn’t a viable option for Mr. Powell–not with inflation running at a 40-year high and the WTI oil price vaulting above $110 per barrel.

Commodities are indeed soaring, but the inflation doesn’t end there; rents have soared by 20% year over year, which is closer to the actual rate of inflation, rather than the massaged 7.5% CPI reported by the Labor Department. If inflation were to continue to increase even close to that rate, it would push those in the middle class into the lower class; and those in the lower class into poverty. Of course, this would end up destroying markets and the economy anyway. It could also put at risk confidence in the U.S. dollar and sovereign bond market.

Therefore, the Fed is now forced to combat inflation whether it really wants to or not. At the nucleus of the inflation issue is runaway owners’ equivalent rent costs, which at 30%, make up the greatest weighting in the CPI metric. But to tackle owner’s equivalent rent inflation, Mr. Powell must first pop the record-setting real estate bubble. The negative ramifications of accomplishing this task for the banking system and economy will be enormous.

Nevertheless, if Mr. Powell prosecutes his plan to raise rates six or more times this year—just as the Fed destroys the money supply by shedding a trillion dollars in Treasuries and Mortgage-backed Securities–the upcoming recession could quickly morph into a depression.

So, which is it, Mr. Powell? Keep monetary policy loose and risk an intractable rise of inflation and the complete loss of confidence and credibility of the central bank. Or tighten monetary policy enough to deflate the massive bubbles in bonds, real estate, and equities. Either strategy is now destined to end in disaster for the market and economy.

Such are the consequences derived from the Fed counterfeiting trillions of dollars for the purpose of distorting and obliterating free markets.

The bottom line is this: the view of Pento Portfolio Strategies is that the Fed will now be forced to tighten monetary policy into one of the greatest decelerations of economic growth and earnings ever. A great defense is always a requirement in a winning portfolio strategy.

Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”  and Author of the book “The Coming Bond Market Collapse.”

February 7, 2022

 The current Fed Chair is perhaps best known for his quick pivots from hawkish back to dovish and vice versa. Maybe he is just too dependent on the prevailing winds of the current economic data. Or, perhaps more accurately, he is most swayed by the performance of the stock market. In either case, Jerome Powell received more reasons to become hawkish just one day following his already hawkish FOMC press conference.

The Bureau of Economic Analysis reported Q4 2021 GDP growth at a 6.9% SAAR. This is a big problem for the Fed, since it falsely believes inflation comes from an economy that is growing too fast. Add in the 7% CPI print for December, and you have a Fed that now understands it is far behind the inflation curve and it’s time to pivot towards an even tighter monetary policy stance. Nevertheless, the FOMC fails to grasp the rapid growth and inflation was engendered by unprecedented fiscal and monetary stimulus, which has now gone in reverse.

Hence, what you have in reality is a massive fiscal and monetary drag that is already set to drive GDP growth towards the flat line. And, when you factor in the inventory build, which added 4.9 percentage points to the GDP figure in Q4, you get a slowdown this year that will be profound. But despite this organic slowing of the economy, inflation will be much more reluctant to become tractable. Rising energy prices, higher wages, and surging Owner’s Equivalent Rent values should keep CPI well above the Fed’s 2% target throughout most of 2022. Indeed, average rents rose 14% last year to $1,877 a month. In certain cities like New York and Miami, the yearly surge increased by as much as 40%, according to data from real estate firm Redfin.

Also pushing Powell along with his tighter monetary policy stance will be the data on inflation-adjusted incomes. Real disposable personal income decreased by 5.8% in the fourth quarter of last year.

What this all means is the dithering Fed will now be forced to catch up with the process of raising interest rates off the zero bound range and start draining its $9 trillion balance sheet. But this tighter monetary policy will occur in the context of an economy that is already slowing down. The Atlanta Fed estimates Q1 GDP growth at just 0.1%. Members of the FOMC have made it clear that they will look right past the first quarter weakness because of the Omicron variant’s negative effect.

The rapid drop in GDP growth, alongside the continuing headwinds of fiscal and monetary drags, should ensure that any stock market rally enjoyed in the remainder of Q1–following the January drubbing of equities–should be short-lived. Powell has well-telegraphed that the liftoff from the zero bound range will happen in March. And, unless inflation surges higher from the current 7% level between now and then, that first rate hike will be just 25 bps, not the feared 50 bps. Wall Street is prepared for that gentle liftoff and should be able to sustain the mild blow.

Nevertheless, by the end of the second quarter, the full impact from the monetary meltdown should begin to be felt. During May and June, the second and third interest rate hikes should take place. Also, in June, the FOMC will lay out its plan for the commencement of draining its massive $9 trillion balance sheet (QT) and also layout the pace of its decline. We can derive some clues about the Fed’s second QT operation by analyzing the statements made by the Fed Chair during his last press conference.

There are two salient quotes from Mr. Powell’s press conference. Regarding rate hikes, the Fed Chair stated, given the strength of the labor market and economy, “I think there’s quite a bit of room to raise interest rates without threatening the labor market.” The second and perhaps more important statement from the Fed-head was made in response to a question about the pace and timing of the Quantitative Tightening program. Powell said, “The balance sheet is much bigger and [its composition] has a shorter duration. And the economy is much stronger, and inflation is much higher. So, that leads you to being willing to move sooner than we did the last time and also perhaps faster.”

By how much should we expect the Fed to reduce its balance sheet? Well, Powell didn’t put an exact number on how much will be shed. But he did say he will “Significantly reduce the size of the balance sheet.” He also said he wants the Fed’s asset holdings to be limited to Treasuries. This means Powell will need to dump all of the $2.7 trillion of Mortgage-Backed Securities it currently holds on the market in relatively short order. That could spell disaster for the real estate market, which is the most overvalued in history based on the home price to income ratio, and was built on the back of record-low mortgage rates.

The Fed again had the temerity to try and claim this upcoming QT regime would simply run innocuously in the background—just like they claimed the last one would before stocks plunged and the REPO market froze. Previous Fed Chairs claimed that QT would be so uneventful it would be like watching paint dry. Let’s see just how true that is. The first time the Fed began draining its balance sheet was in October of 2017. The initial pace of asset reduction was $6 billion of Treasuries and $4 billion MBS. But by 2018, that pace increased to $30 billion in Treasuries and $15 billion in MBS. However, the stock market began to revolt by the fall of that same year. This prompted the Fed to announce in March of 2019 that it would cut in half the rate of asset sales starting in May and would cease QT entirely by September. As it turned out, the Fed had to completely end QT even earlier than indicated due to the 30% plunge in the Russell 2000 and the complete dysfunction in credit markets.

What all this means is that while Powell may desire to pivot back to a Dove as the stock market and economic data begins to falter, he cannot easily do so…not while inflation has risen to a forty-year high. During the previous round of QT, inflation was below the Fed’s 2% target. Powell no longer has the luxury to claim inflation is quiescent. Also, the Fed’s balance sheet has doubled since the first QT program. That is why the upcoming iteration of QT will likely run at twice the $45 billion per month pace seen when the first failed attempt to reduce the balance sheet began.

Of course, the Fed will eventually pivot back to Quantitative Easing to rescue the markets. But that will most likely be after the credit markets freeze and/or the major averages plunge greater than 30%. Until then, the Fed must continue to fight the battle against all-time, record-high inflation. Jerome Powell’s calculation is easy: defending the portfolios of the wealthiest Americans cannot take precedence over continuing to destroy the purchasing power and living standards of the voting middle class. Buy and holders of the 60/40 portfolio, better beware!