A systemic crisis in the debt market festers as the Fed’s pitiful fight against inflation, which has not even raised the Fed fund rates above the pampered core inflation rate, threatens to collapse the house of cards bond market, taking banks with it.
US annual core inflation, the data that strips out everything relevant, like food and shelter, is 5.5%, meanwhile, the current Fed fund rate is 5%.
If the Fed were serious about fighting inflation, it would need to raise rates another 500 basis points to 10% because real inflation is in double digits. But it can’t.
The market and the economy are so financialized that restrictive monetary policy is now likely to trigger a systemic crisis.
Darren Winters doubts that the Fed can raise rates above the current core inflation rate, which doesn’t give an accurate picture of inflation, without exacerbating a bank liquidity crisis and provoking more bank runs.
The Fed’s pitiful fight against inflation is over.
More meaningful rate hikes from here, and we go into a financial, economic meltdown. It would be a mad max scenario.
In a piece entitled, Headlines in 2023, dated December 2022, it was written,
“Strikes, cost of living protests, and riots could all fill the headlines in 2023.”
Europe’s spring protests have already begun in France. Paris is burning, and Bordeaux town hall has been set on fire. We are likely to see these protests repeated in other major European capitals.
We are living through the worst bond crisis, a potential systemic crisis of the century
“Here is the 800-pound gorilla; the 24 trillion USD treasury market, the pinnacle of prime western collateral, remains negative yielding, in the face of 7.2% inflation,” written in part two Headlines in 2023.
So consecutive Fed rate hikes and quantitative tightening triggered a sell-off in the bond market, which sent corresponding treasury yields higher.
Higher treasury yields are the crux to the bank runs in 2023 as investors rotated funds out of low-interest bank deposits into higher-yielding treasuries to compensate for higher inflation.
US treasuries, the pinnacle of prime western collateral, have low credit risk and high maturity risk, particularly in a backdrop of high inflation and Fed rate hikes.
The maturity risk of US treasuries, which is not taken into consideration in bank stress tests, poses a systemic crisis
Silicon Valley Bank blew up not because of the credit risk but due to the maturity risk of these treasuries.
These treasuries were sitting on SVB’s portfolio at sizable book-to-market value losses.
SVB could not sell these treasuries without realizing sizable losses and collapsing the bank’s collateral base and liquidity.
In short, SVB is not an isolated case but a floodgate case of a global contagion liquidity crisis in banking, bearing in mind treasuries are prime collateral for banks.
The systemic crisis has its roots in the unfettered US public deficit, and waning global demand for treasuries
Treasury Secretary Janet Yellen testified about the budget 2024 before the Senate Appropriations Committee; on March 23.
The proposed budget for the next fiscal year is approximately 500B dollars more than this fiscal year.
Kennedy; “Since 2019, since today, the US population has increased by 1.8%, and the Federal government is up 55%. Is that not a fact?”
Yellen; “Well, we had a pandemic.”
Kennedy noted that the Biden administration proposed budget is for 4.7 trillion dollars in new taxes.
Yellen; “Yes, it does propose several additional taxes.”
Kennedy; “Under Biden’s proposed budget, the gross debt will rise from 32.7 trillion US dollars from the close of this year to 51 trillion US dollars in 2033. Is that not a fact?”
Yellen, looking flustered, “Yes, that is probably a fact.”
Kennedy; “So you have not reduced the deficit.”
Yellen gives a meaningless reply, “The deficits and debts are reduced by the president’s budget.”
Kennedy; “How can you go from 33 trillion to 51 trillion dollars and call that a reduction in the deficit.”
Another meaningless Yellen reply;
“Because that is a calculation for which you need a baseline, then you compare the budget and deficit in debt in the budget with the baseline …” then Kennedy cuts, “Here is my baseline, if the president’s budget is implemented the debt will rise from 33 trillion to 51 trillion by 2033.
Yellen; “If the President’s budget is not implemented and no changes made, it will be worse than that.”
“The president’s budget has improved the fiscal outlook relative to what we would have without the president’s proposals,” she adds.
Kennedy; “Gross debt is being raised from 32 trillion dollars to 51 trillion dollars, that includes taxes. In what world is that an improvement other than in Washington and la la land.”
Fed was aware of banking stress, and potential systemic crisis but keeps hiking
In January 2019 Fed issued a warning to Silicon Valley bank over its risk management system.
Kennedy; “Is it not a fact that the month before SVB went under the bank disclosed that its market to the market value of its bonds was 16 billion US dollars less than their balance-sheet value.”
Yellen “They did make such a statement.”
Kennedy; “SVB was not stress tested in 2022;34 banks were stress tested.”
Kennedy;” Is it not a fact that if SVB had been stress tested, it would have passed.”
Kennedy; “When it stress tested in 2022, it only stress tested credit risk, not duration risk.”
Yellen; “I believe stress tests in general partially take into account interest rate risk,”
Kennedy; no mam, I read it. It is not there.
Systemic crisis and geopolitical bipolar investor diversification
Paradoxically, sanctions on Russia have sheltered its financial system from western contagion.
As Darren Winters points out, he has not read about any bank in Russia collapsing, inflation remains relatively stable, and the Rouble has not turned to rubble, it is recovering from its lows. BRICS looks attractive, countries like Argentina now want to join.
Meanwhile, safehaven Switzerland banks are in trouble. Credit Suisse collapsed leaving bond investors with billions of losses
Has the West lost its mojo?