Believe in a Soft Landing ... Yeah, and That Inflation Was 'Transitory'

The S&P 500 is down 10% in just the last two weeks with U.S. 10 year bonds collapsing as the 10-year yield touches past 3.88%.

This was trading just close to 3.2% a few weeks back and bonds seem unable to catch a bid. Investors try and buy the market in fear of missing out, only to be disappointed yet again as the markets give back gains as the Fed reveals it's not over its inflation fight.

Rinse and repeat.

This has been the state of the markets since August, as the only excuse to buy the market or any asset is that the Fed is soon going to print even more to support markets. Thanks to the Fed's Modern Monetary Theory experiment since 2001, the market has only been able to function if liquidity is injected into it, and collapse if not. These cycles have gotten a lot shorter and more violent as the economy is even more levered after each cycle making each quarter percentage point rate hike in interest rates much more sensitive.

The case for equities being "cheap" is often echoed in sell-side buy calls here, but it is not about how compelling the valuations may look, as the market is still above March 2020 levels in some cases. If one goes back to see where we have come from or where, say the PE Shiller Index trend price-to-earnings multiple should be, one can see it fall much more if "things were to come back to a neutral" state. We have been above trend and defying all economic metrics since this crazy Fed experiment started.

Cheap is relative -- only if you can trust the "E" of the P/E metric. One can argue that these downgrades have yet to be reflected in the analysts' numbers. The Fed boosted trillions of dollars into markets to jump start the economy and that caused a demand surge unlike past cycles to get all assets to reach new highs causing an inflation shock to the system. When demand moves up this much in a short span of time, the supply side is unable to catch up, but eventually something has to give. Either demand needs to fall or supply plays catch up. In this case, the former reached a tipping point where the economy started to roll over.

The Fed has no choice but to keep raising rates as it needs demand to be contained to ward off secular inflation as we saw back in the 1970s. The Fed is making an effort to do what it takes to combat this surge in prices. This is in direct contrast to the Bank of England that raised interest rates only to then issue a mini budget that is looking to raise debt by another £120 billion over the next three years.

It is no wonder that the Sterling collapsed 5% in just a few days as no other central bank in the developed markets is being as aggressive as the Fed. Where will all this money come from? Who will ever pay down this debt? We seem to have never learned the ways of Japan, as they have been embarking on the same Modern Monetary Theory experiment for decades. 

Now, the yen is hopeless as it fails to rally despite the Bank of Japan intervention. Their need to sell even more U.S. treasuries to raise funds to buy the yen implies even higher rates for U.S. bonds and eventually a higher dollar. This negative feedback loop is making matters worse but central banks know not what else to do. The debt bubble is too big to fail and every central bank knows that eventual truth.

For now, Fed Powell is waiting for the data to justify the U.S. central bank to stop raising rates, but to no avail. The central bank's key focus is to get inflation under control and back to the 2% target level. It remains to be seen if the Fed will be successful in doing this -- while it's convinced it will achieve a soft landing.

But then again, they also said inflation was transitory.

At the time of publication, Bengali had no position in any security mentioned.