Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

The monetary flood did not solve the problem, it just delayed the crisis further back. It is a redistribution of benefits, with those who came early making a lot of money and those who came later paying a huge price.

The cost must be borne by someone.

A flood of money doesn’t solve the problem, it just delays the crisis further back. This is a redistribution of benefits, the early comers earn a lot of money, later people pay a huge price.

The liquidity feast is nearing its end, and the market is getting more and more fragile, with the wind and the grass at their backs, lest they run late and become the ones paying the bills.

May 13, the global market is shaky, overnight the U.S. market stocks and bonds double kill, Japanese stocks, A shares and Taiwan stocks plunged, European stock markets also opened in a straight line down:.

Overnight, the Dow fell 681 points, or 1.99%, the largest one-day drop since January this year. The S&P 500 fell 2.1%, the biggest one-day drop since February this year, and the Nasdaq fell 2.6%.

The Nikkei 225 closed down 2.49%, after falling a heavy 6.5% for the week, while the TSE fell 0.8%. Taiwan stocks opened down 3% and were down 8.6% at one point in yesterday’s session. The Shanghai index fell 0.96%, the Shenzhen index fell 1.05% and the GEM index dropped 0.57%.

European markets opened with the European Stoxx 50 index down 1.33%, the UK FTSE 100 index down 1.40%, the German DAX index down 1.35%, the French CAC 40 index down 1.22% and the Spanish IBEX 35 index down 0.93%.

The market is panicking again! The logic chain of panic is: soaring inflation – the Fed rate hikes – bubble burst!

The key question is, does this logic hold?

01

The source of this market storm, from the U.S. inflation data.

On May 12, the U.S. Department of Labor released inflation data, inflation, core inflation are greatly exceeded expectations, year-on-year and chain rate of growth are also hitting a multi-year high, greatly stimulated the nerves of investors.

U.S. April overall CPI jumped 4.2% year-on-year, significantly exceeding previous market expectations of 3.6%, the growth rate hit a new high since September 2008; April core CPI jumped 3% year-on-year, higher than market expectations of 2.3%, the fastest growth since January 1996.

On a year-over-year basis, the overall U.S. CPI rose 0.8 percent in April, also the largest year-over-year increase since June 2008; core CPI rose 0.92 percent, the largest increase since 1981.

“Inflation soars – Fed raises rates – bubble bursts!” The logic was clear, so the market sold off sharply.

As we analyzed in our article “The Limits of Fed Expansion.

The US is currently practicing MMT theory, which does not look at asset bubbles, only inflation. The core constraint is: inflation.

The reason is also simple: hyperinflation usually has common problems: social unrest and political turmoil, civil war, collapse of productive capacity, weak government, foreign debt denominated in foreign currency or gold, etc.

Typical examples are, for example, the Weimar government of Germany, the gold rounds of the Republic of China, Zimbabwe, Hungary, etc.

Therefore, MMT theory practice must control inflation!

Therefore, only inflation will cause the Fed to tighten liquidity, and only inflation will burst the asset bubble!

The Fed’s traditional monetary policy framework, as well as under the MMT theory practice, have a common focus: inflation.

The logic is clear, and there is nothing logically wrong with the market staring at inflation to make a deal.

What is the current market situation? From a period of inflationary concerns into a period of inflationary sensitivity.

In the preceding months, global commodity prices have risen sharply in succession, inflationary concerns have been deeply rooted, but not specifically reflected in economic data.

Yesterday, the U.S. inflation data kicked off the curtain, the U.S. inflation in the next few months with other countries will continue to be high, constantly stimulating the fragile nerves of the market!

Market sentiment is pessimistic when any negative factors will be magnified, as will market concerns about inflation.

For example, the intensity and duration of this round of inflation may hit a new high since the “stagflation” crisis in the last century, due to the short-term dislocation of the epidemic, the game of big countries and the medium- and long-term carbon emissions reduction, supply chain contraction and other factors.

Therefore, we expect that in the next few months, inflation will become the norm to stimulate the market.

02

Front-line market traders are trained to make knee-jerk reactions to economic data such as inflation.

This leads to a market that is very sensitive and able to reflect market information immediately.

But in the long run, or when looking at trends, the knee-jerk reaction of traders, or short-term market volatility, is sometimes “wrong”.

To see the big trends in the market, you have to filter out the effects of short-term market fluctuations.

How do you spot the big trends? It is also necessary to further analyze the information of the market knee-jerk reaction to see if the market is wrong at the moment.

Specific to the current market environment is that it is very important for us to look at how inflation affects Fed policy.

Or rather, when will the Fed raise rates? Ultimately, it also depends on the Fed’s decision-making mechanism.

In August 2020, the Fed revised its monetary policy framework, and one of the points is that it revised the level of tolerance for inflation indicators. This may also be the prototype of the Federal Reserve’s monetary policy framework under the MMT theory.

The core change is just one: the original long-term target of Fed policy is 2%, and now it becomes the long-term average inflation rate is 2%.

The Fed allows inflation to be slightly above 2% for a period of time. The problem is that it is not known how long this period is; how to calculate the 2% average inflation, the Fed is also all but incoherent.

I have speculated before that if expected inflation in the U.S. is above 3% or even 4% for almost a year in a row, while economic growth data is quite good, then the Fed policy may turn trend.

Which data to keep an eye on? For the Fed, monetary policy decisions are based on the Federal Reserve Board’s Summary of Economic Outlook (SEP). Just keep an eye on this report.

03

For readers who like to look at models and theories, this analysis may not seem like enough, so let’s look at the Fed’s decision theory next.

Before we do that, let’s be clear about one thing that characterizes regulatory agencies or bureaucracies: fine-tuning.

For Fed officials, it is optimal to make policy decisions according to previously established decision-making mechanisms, because if they risk adopting completely new mechanisms, they are responsible for what goes wrong.

However, they will not completely copy the previous decision-making mechanism, because they also need to “performance”, rather than to the previous “work”, in the previous credit book on a record.

Therefore, they will make adjustments to the decision-making mechanism.

In the century of development, the ultimate goal of the Fed’s monetary policy has changed repeatedly, and finally established the dual goal of stabilizing prices and ensuring full employment.

The most classic one is, the Taylor formula proposed in 1993.

Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

There are so many theories, why the Taylor formula will be valued?

In fact, it is very simple, that is, Taylor through this model, regression analysis of past historical data, the results look: it turns out that the practice of the Fed for so many years in the past, and I this model fits very well.

Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

And over the past years, there has not been much of a mess, and even when there has been a mess, it has been within manageable limits. So it was assumed that the model could be used for the present and the future.

Besides, even if the Fed officials use this model to screw things up, they have an excuse to say, “Look, everyone has been making decisions like this in the past, and we’ve been making decisions like this, so we can’t be blamed for it.

After the outbreak of the global financial crisis in 2008, the Federal Reserve directly lowered interest rates to zero, leading to a serious asset bubble.

So, many people are criticizing Bernanke, you so messed up can not ah, after the big event you are responsible for ah?

Of course Bernanke also need to refute these, saying that you have no practical experience of scholars ah, too naive. The real world is far more complex than your assumptions, and I certainly have theoretical support for the development of policy.

So Bernanke amended the Taylor rule, adjusting the weight of economic growth from 0.5 to 1.

Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

Then, having done the regression analysis, I told you, see, I have this model, which perfectly simulates the interest rates of the past many years, and also explains the doubts that people had about me in 2008 and 2009.

The theoretical interest rate in 2008 and 2009 was negative. I lowered the interest rate to 0 because I couldn’t lower it any further.

Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

This model greatly strengthens Bernanke’s policy determination, because later if out of the problem, Bernanke is able to shake the pot. If the economy is really good, then the credit is my personal, not much to do with Taylor.

Yellen’s time is the same, except that she put more emphasis on the U.S. labor force participation rate. So, when the U.S. economy was recovering, the U.S. labor market was not up, so the Fed did not raise interest rates immediately after the launch of QE.

He Fan also summarized the “Yellen rule” according to Yellen’s view.

Global markets fell The tragic price of liquidity flooding? The key is to look at these two indicators!

66.5% is the labor force participation rate, because for the past many years, the average labor force participation rate in the United States is 66.5%.

How does Powell, specifically, make the decision to raise interest rates?

1, there is a key variable, the average level of inflation.

It used to be inflation, but now it is the average inflation, specifically how many years of inflation level? This depends on how Powell does the model.

There is an advantage to not publishing the specific number of years of average is that it is convenient for the Fed to adjust the model. According to the final decision, find the appropriate N-year average.

2, another key variable is that the labor force participation rate.

What exactly is the recovery of the core economy, GDP growth data, PMI data, and even commodity data, etc., are quite “superficial”.

The U.S. is prepared to do a lot of work this time, not the economy is completely good, is not going to stop. Therefore, the Fed needs to focus on the biggest shortcomings, the labor force participation rate.

And this is also the biggest problem of the U.S. economy at the moment.

What to look at, the U.S. macroeconomic data is quite good, but the employment data is still a mess, because the epidemic government subsidies more, people are not working.

What is happening now is that Americans are taking money from government subsidies, they are not employed, they are not going into production, they are sitting at home buying (importing) goods from China.

For the United States, this model certainly does not work, it is very fragile ah. For the U.S. economy to really turn around, not only do we need to let Americans consume, we also need to let Americans work and produce.

So, the U.S. labor force participation rate went up, the U.S. economy is really good.

For those who are interested, you can do a simulation of the N-year average inflation level, the U.S. labor force participation rate, and the output gap. If the model you make is close to the actual situation in the past, then the model you make is likely to be similar to the Fed’s model.

To summarize, the current Fed policy has two constraints.

  1. Inflation. Single-month inflation is not much of a problem as long as it does not exceed double digits. Average inflation over the year is not much of a problem as long as it does not exceed 3% or 4%.

2, the expected U.S. labor force participation rate, as long as it does not reach the average level, that is, 66.5%, the Federal Reserve will not raise interest rates.

For the market only, after the formation of expectations and consensus, the market usually reacts before the Fed’s specific actions.

For example, in 2013, the Fed has not yet tapered QE, Bernanke in the congressional hearings, mentioning the reduction of QE, the global financial markets plummeted.

It is still too early for this kind of panic. The market at the moment is completely scaring itself, and there is no consensus on inflation, labor participation rate and so on.

So, in the next few months, the market may really plunge due to inflation panic, but every plunge is an opportunity to bottom out!

It’s far from time to pay off the debt!

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/global-markets-fell-the-tragic-price-of-liquidity-flooding-the-key-is-to-look-at-these-two-indicators/
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