US & Americas Political Macro Commentary – December 29, 2021

Nicholas Glinsman | December 29th, 2021

·         No rest in the criticism of the Fed

·         Credit ratings firms could be in the spotlight again

·         Biden could well announce Sarah Bloom Raskin as top Fed banking regulator, in what would be bad news for the banking sector

·         One of the oldest tradeable assets versus one of the newest – corn versus bitcoin

·         Another chart comparison – ARKK versus NOKIA

·         Mexico’s outgoing central bank governor calls to protect its independence

No rest in the criticism of the Fed

The current article getting focus is the following in Politico by former Fed governor Thomas Hoenig:

It is worth a read in full, and if you do, approach it with this warning from Paul Volcker in mind:

“The real danger comes from [the Fed] encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets.”

Here are some key highlights:

“Between 2008 and 2014, the Federal Reserve printed more than $3.5 trillion in new bills. To put that in perspective, it’s roughly triple the amount of money that the Fed created in its first 95 years of existence. Three centuries’ worth of growth in the money supply was crammed into a few short years. The money poured through the veins of the financial system and stoked demand for assets like stocks, corporate debt and commercial real estate bonds, driving up prices across markets. Hoenig was the one Fed leader who voted consistently against this course of action, starting in 2010. In doing so, he pitted himself against the Fed’s powerful chair at the time, Ben Bernanke, who was widely regarded as a hero for the ambitious rescue plans he designed and oversaw…

Hoenig is remembered as something like a cranky Old Testament prophet who warned incessantly, and incorrectly, about one thing: the threat of coming inflation. But this version of history isn’t true. While Hoenig was concerned about inflation, that isn’t what solely what drove him to lodge his string of dissents. The historical record shows that Hoenig was worried primarily that the Fed was taking a risky path that would deepen income inequality, stoke dangerous asset bubbles and enrich the biggest banks over everyone else. He also warned that it would suck the Fed into a money-printing quagmire that the central bank would not be able to escape without destabilizing the entire financial system.

The Fed is now in a vise. Inflation is rising faster than the Fed believed it would even a few months ago…

“There is no painless solution,” Hoenig said in a recent interview. “It’s going to be difficult. And the longer you wait the more painful it will end up being.” To be clear, the kind of pain that Hoenig is talking about involves high unemployment, social instability and potentially years of economic malaise. Hoenig knows this because he has seen it before. He saw it during his long career at the Fed, and he saw it most acutely during the Great Inflation of the 1970s. That episode in history, which bears eerie parallels with the situation today, is the lodestar that ended up guiding so much of Hoenig’s thinking as a Fed official. It explains why he was willing to throw away his reputation as a team player in 2010, why he was willing to go down in history as a crank and why he was willing to accept the scorn of his colleagues and people like Bernanke. Hoenig voted no because he’d seen firsthand what the consequences were when the Fed got things wrong, and kept money too easy for too long…

There is strong evidence to support Hoenig’s view that the Fed was fueling inflation during the decade of the 1970s. In a 2004 report, the Fed economist Edward Nelson wrote that the most likely cause of inflation during the ’70s was something he called “monetary policy neglect.” Basically, the Fed kept its foot on the money pedal through most of the decade because it didn’t understand that more money was creating more inflation. This kind of inflation is called “demand pull” inflation, meaning that the Fed stokes demand, which causes prices to increase.

The author and economist Allan Meltzer, who reconstructed the Fed’s decision-making during the 1970s in his 2,100-page history of the central bank, delivered a stark verdict. It was monetary policy, set by the Fed, that primarily created the problem. “The Great Inflation resulted from policy choices that placed much more weight on maintaining high or full employment than on preventing or reducing inflation,” Meltzer wrote. “For much of the period, this choice reflected both political pressures and popular opinion as expressed in polls.”

Hoenig carried these lessons with him. He was promoted to become the president of the Kansas City Fed, in 1991, which gave him a voting seat on the FOMC. He served there during the long tenure of Fed Chair Alan Greenspan, and then Greenspan’s successor Ben Bernanke. Between 1991 and 2009, Hoenig rarely dissented. Then came 2010, when he believed the Fed was repeating many of the same mistakes it made in the 1970s.”

This is a powerful indictment of Fed policy. It is why we are in a trap with no good choices. Powell MUST fight inflation and ignore the market or it all goes FUBAR.

Furthermore, as you know, there are many critics of the Fed. There are also many worried about the current buoyant stock market, such as Bill Stromberg, the chief executive of T Rowe Price, who will retire at the end of this year. In an interview with the Financial Times, he warns that investors should “step away from risk” to avoid being burnt in an increasingly speculative market. “Over [the] last two years there has been a way above-average amount of speculation. We’ve been in a cycle where there has been very free-form risk-taking.”

Credit ratings firms could be in the spotlight again

Insurers have been buying up privately issued bonds to earn higher yields in a low-interest rate world. Now, state regulators are demanding more information about these investments, which back many Americans’ life-insurance policies. Starting in January, insurers will need to file details about the credit ratings for the privately issued bonds that they purchase. Regulators are concerned that the ratings potentially understate the risks of the securities.

Regulators also will examine how well the current ratings process works to protect against losses. The regulators are working through the National Association of Insurance Commissioners, a standard-setting group for the state-regulated industry. The NAIC is tasked with trying to determine whether the bonds themselves are riskier than their ratings indicate. If so, that could mean unexpected investment losses for insurers. 

Sounds very much like the mortgage-backed securities ratings fiasco, which got exposed in the GFC. Of course the ratings firms say they have improved their corporate governance, analyses and compliance processes since the crisis. One thing that hasn’t changed is a conflict of interest that is inherent in their business model: In general, the firms are paid by the companies whose bonds they rate. Companies have incentives to hire the firms that give them the highest ratings because it means a lower cost to borrow.

Now regulators are especially concerned about the ratings on private securities, which don’t trade publicly and are often held by a small number of investors. More than 5,000 privately rated securities were on insurers’ books this year, up from fewer than 2,000 in 2018, the NAIC said. That compares with more than 300,000 separate securities held across all insurers, totaling trillions of dollars. Starting next year insurers will have to file reports that detail the private ratings received on new investments, which apply particularly to customized financial instruments. Private ratings are supposed to be done the same way as public ones, the NAIC said, so it anticipates receiving reports comparable to what is publicly available on other bonds.

In December, a task force of state regulators at the NAIC said there would be additional, broader scrutiny on all bond ratings after NAIC staff found that firms sometimes have given the same securities widely different ratings. In some cases, private ratings differed by five notches, meaning that one firm considered a bond high quality and safe, while another judged it to be weaker in quality with relatively high risk. Public ratings also sometimes varied, though to a lesser degree. The staff also reviewed 43 privately rated securities and found risk to be materially higher than their ratings indicated.

Watch this space, as there could be some repercussions, given the ratings companies are being paid by the firms whose bonds they rate!

(hat tip SD)

And in related financial sector news…

Biden could well announce Sarah Bloom Raskin as top Fed banking regulator, in what would be bad news for the banking sector

Let me explain why?

Raskin’s nomination would clearly be aimed at mollifying progressive Democrats, some of whom opposed Biden’s decision in November to offer a second term to Fed Chairman Jerome Powell, a Republican first chosen for the top job by former President Donald Trump. They have called for the Fed to take a tougher stance in regulating big banks and a bolder approach in addressing financial risks posed by climate change.

And that’s what they will get. In a speech in September 2009, Raskin blamed the financial crisis on “a deregulatory fervor that marginalized the interests of many” and said the downturn had been “brought upon us through a combination of greed, weak regulation and weak enforcement.”

While serving as a Fed governor from 2010 to 2014, Raskin was deeply involved in behind-the-scenes work to write rules implementing the 2010 Dodd-Frank financial-regulatory overhaul. Since leaving the government, Raskin has spoken out on the need for the Fed and other federal financial regulators to more proactively address growing threats from climate-related events such as natural disasters and wildfires. “There is opportunity in pre-emptive, early and bold actions by federal economic policy makers looking to avoid catastrophe,” Raskin wrote in the foreword of a report last year from the Ceres Accelerator for Sustainable Markets, a climate advocacy group.

More recently, in a New York Times opinion article in May 2020, Raskin was critical of broad-based emergency-lending backstops enacted by the Treasury and Fed to assist businesses during the pandemic because she believed they should have taken steps to prevent lending to oil-and-gas concerns. “The decisions the Fed makes on our behalf should build toward a stronger economy with more jobs in innovative industries—not prop up and enrich dying ones,” she wrote.

I should add that Biden is also considering two more progressives for Board seats: economists Lisa Cook of Michigan State and Philip Jefferson of Davidson College. If nominated and confirmed, along with Raskin, that would fill all seven seats on the Fed’s board, including with a female-majority board of governors. Cook and Jefferson are both Black economists. The Fed has only had three Black governors, and none since 2006.

Of note, this Fed has lost most of its GOP representation, and as such, will swing to the progressive left over the next year, making the fight against inflation that much harder for Chair Powell.

One of the oldest tradeable assets versus one of the newest – corn versus bitcoin

Simply in one 2-year chart:

And indeed, food prices are going up further, according to the Wall Street Journal, which discusses the issue as being are part of what businesses and economists call the highest inflation in decades. Higher wage, material and freight costs are prompting industries from manufacturing to retail to raise prices of goods, creating an environment in which some executives say they have room to charge more.

“The Labor Department said the consumer-price index rose 6.8% in November from a year ago, the fastest pace since 1982. The food-at-home index, which includes purchase from grocery stores, rose 6.4% over the past 12 months, with meats, poultry, fish and eggs increasing 12.8%.

Coming price increases in 2022 range from as low as 2% to 20%, hitting all sections of the grocery store including produce and packaged goods. Potatoes, celery and other heavier vegetables will have higher price tags next year in part because of higher freight costs, supermarket executives said. Wine, beer and liquor are also likely to get more expensive, they said, especially those that are imported.

Pantry staples such as mayonnaise and frozen meals are expected to be more pricey partly because of higher labor, logistics and packaging costs, some executives said.”

Meanwhile, talking of staples, Brazilian prices for arabica coffee, the world’s most-popular variety, are headed for the biggest annual gain in records going back to 1996 after freakish weather hurt the crop in key farming regions. Severe drought and the worst freeze in decades did so much damage in the world’s top producer of beans that the growth potential has been crippled for at least the next two seasons. Global shipping snarls and swollen container and fertilizer prices are compounding cost pressures across the industry.

Of course, this has been reflected in the international market:

And whilst on the subject of commodities, look at what is coming back with a vengeance – lumber:

Another chart comparison – ARKK versus NOKIA

The ARKK vs Nokia chart continues developing according to “plan”. At least Nokia tried transforming the world and actually was the leader for a while. ARKK on the other hand is innovating little…

Mexico’s outgoing central bank governor calls to protect its independence

The Bank of Mexico’s outgoing governor, Alejandro Díaz de León, has spoken out about the importance of protecting the bank’s constitutional mandate as the institution faces mounting political pressure from President Andrés Manuel López Obrador and his party. The bank’s autonomy was recently called into question when López Obrador withdrew his nominee to be the next governor and replaced him with a little-known public sector economist. 

The outgoing governor said he was confident the bank would continue to fulfil its mandates so long as its legal framework stayed intact. “The key thing is to conserve the constitutional mandate and the law that the bank has today,” Díaz de León told the Financial Times in an interview. “I think those are the best guarantee that an environment of stability and low inflation can be maintained.”

Tensions between the central bank and politicians began to mount last year when a bill proposed by lawmakers from the ruling Morena party sought to force it to buy excess dollars. The proposal would have undermined the bank’s autonomy, critics said. It was eventually shelved after strong opposition. The central bank’s board also ran into political controversy this year when it pushed back against López Obrador’s attempt to use Mexico’s share of a global liquidity injection from the IMF to pay off public debt.