Are We Back To The Everything Bubble?

Estimated Reading Time: 6 minutes

The term everything bubble was coined when seemingly all investments started to rise in unison, apparently in response to massive liquidity injected into the economy by both the Federal Reserve (monetary policy) and massive Federal deficit spending (fiscal policy). Many also believed that the force pushing all asset prices up at the same time was the era of zero interest rates.

While the inflation of asset prices has continued, it seemed to take some time before the price level of everyday purchases started to rise sharply.  Some have suggested this had to do with macro factors such as globalization and demographics. Whatever it was, there was a surprising delay but in the past few years, consumer price inflation has hit with full force.

A rise in asset prices is especially enjoyed by those wealthy enough to own stocks, bonds, real estate, gold, commodities, and cryptocurrencies.  This has helped magnify the wealth gap between the ultra-rich and the rest of us.

The only markets not participating of late are the bond market, locked in a four-year bear market, the worst in history, and sectors of commercial real estate. Everything else seems to be floating higher pretty much together once again.

But since most people are not that wealthy, and may own either a limited amount or no assets at all, the sharp rise in consumer prices has caused a political firestorm. Wages have risen much slower than either the cost of consumer items or the cost of credit.

Housing affordability is at the worst level ever recorded. That puts home ownership out of reach for many younger people.

This may explain why we have seen a political switch of historical dimension. The Democrats have become the party of the ultra-rich asset owners and the Republicans have become a working-class party.

The Federal Reserve responded to the bottom-up political pressure of consumer inflation by initiating the sharpest rise in interest rates in percentage terms in American history.  This is because the rate of change from zero to even modest levels of 4% or 5% is a tremendous difference, even though nominal rates are not as high as we saw in the early 1980s.  While the hike in rates has tanked the bond market and made housing  less affordable, the overall economy has seemingly dodged the recession call.

Besides rates, the FED  reversed course on asset purchases for their balance sheet. After years of Quantitative Easing (buying bonds to be held by the FED with money created out of thin air), they have been forced to “tighten” by selling those bonds (Quantitative Tightening.)

Most markets went into a downward corrective phase, but as we wrote last time, few seem to violate anything more than short-term trendlines and moving averages.

But, in the past few weeks, stocks, gold, and commodities are back to their rising trajectory, with many going to new highs. That seems illogical given the market views the FED action as “tightening” money and credit.

So, as the FED increased interest rates and shrank its balance sheet, measures of liquidity (how much money is sloshing around the financial system) were rising again. If that seems contradictory, maybe it is because it is.

With markets going to new highs ,the equity market remains overvalued by almost any metric. And, the economy is not growing nearly as fast as asset markets are escalating. This seems very odd for what has been called “tightening.”

For us, the big question is: How can the “everything bubble” come back if the Fed is tightening money?

This has caused quite a debate among analysts, and we have to admit, that we have found it hard to understand ourselves.

The easiest explanation is that while rates are higher, the FED IS NOT TIGHTENING.

How can that be?

As we pointed out last time, both the Bloomberg Index of Financial Conditions and the Chicago Federal Reserve’s Index of Financial Conditions, both show that monetary conditions are easing and not tightening. In addition, the money supply after contracting somewhat, is back to expanding.

In short, money is not tight although it may be more expensive. That distinction is important.

The reason we think that is the case is that fiscal policy remains very loose, and indeed some estimate only about 17% of the huge stimulus from the CHIPS ACT and the Infrastructure Bill, has even been spent. There are trillions in the pipeline yet to squander.

The other explanation is the FED, like any good magician, has you looking at one thing while doing another. It has raised rates, but it also quietly retreated on the rate of QT balance sheet reductions. Secondly, the FED employs a dizzying array of liquidity facilities that few know much about.

Most investors understand if interest rates go up, it will tend to reduce money and credit. However, the FED has many new tools that only someone with a doctorate in financial plumbing can truly understand.

Here are just a few of these other liquidity facilities the FED and Treasury can employ:

  • Term Auction Facility or (TAF)
  • Primary Dealer Credit Facility (PDCF)
  • Commercial Paper Funding Facility (CPFF)
  • Term Asset-Backed Securities Loan Facility (TALF)
  • Money Market Mutual Fund Liquidity Facility (MMLF)
  • Municipal Liquidity Facility (MLF)
  • Exchange Stabilization Fund (ESF)
  • Supplemental Financing Program (SFP)
  • Capital Purchase Program (CPP)
  • Paycheck Protection Program (PPLF)
  • Treasury General Account (TGA)
  • Reverse Repurchase Agreement Facility (RRP)
  • Bank Term Funding Program (BTFB). This last one JP Morgan says put $2 Trillion into the pot although they quit lending after March 11, 2024.

Have your eyes glazed over yet? In researching this issue, we are not sure this is even a complete list and likely more will be invented when they want to use them. The main takeaway is that there are many sources of liquidity beyond the discount window.

The bottom line is this: the employment of all these liquidity facilities has more than offset the money being taken out of the system through interest rate hikes and QT.

If that is true, markets ranging from stocks to copper are likely unlikely to take any significant correction, at least for a while longer. Of course, the state of liquidity will have to be monitored because while the FED and Treasury can provide credit, they can’t force people to utilize that credit.

For example, banks create money as well through the lending process. But if consumers and businesses don’t want to borrow at these rates, or economic conditions are too soft to warrant borrowing for expansion, money will not get created by banks, and banks in turn don’t need help from the FED. The term of the art is “pushing on a string.”

To be sure, watching all these liquidity facilities, and how they may interact with each other, is a full-time job. For those in a position to do so, many concede the point we are attempting to make. That is, the FED has increased rates and has been slow at lowering them, but that does not mean liquidity is not plentiful enough to drive markets higher.

Liz Ann Sonders, Managing Director and Chief Investment Strategist at Charles Schwab, recently commented on this chart.

She suggests these multitudinous credit facilities have created one the greatest spikes ever in liquidity in the past 50 years, despite the common belief the “FED is tightening.”

Jurien Timmer is a top analyst with Fidelity. He shows that liquidity was contracting, but he too shows it is now expanding. His chart also indicates a close relationship between liquidity and the direction of stock prices.  That is likely more than correlation. When money is plentiful, Wall Street has ingenious ways to use it with leverage.

Where all this will end is worrisome. Government manipulation of credit by the FED, or its new-fangled “facilities,” is blamed by Austrian Theory economists for causing both economic and market booms and busts. We think they have a point. If they are correct, it does not matter if excess liquidity comes from traditional sources or a new alphabet soup of credit facilities. It still creates malinvestment, currency debasement, and the destruction of the middle class. It is all artificial stimulation with printed money, albeit in a new format.

So regardless of the mechanism, currency inflation causes both asset and consumer price inflation.

So the good news is, the FED has not been nearly as tight as most of us thought, and that has supported markets and kept them from correcting.

The bad news is, the overvaluation of markets is because the FED is not really tightening, the excesses are not being wrung out of the markets, and consumer price inflation will be harder to subdue. Because of the latter, that means interest rates are likely to stay ‘higher for longer.”

Monetary economist also point out that simply a reduction in the rate of money printing will cause an economy addicted to inflation to go into withdrawal. In short, the elevated levels of many markets is because the fiscal and monetary authorities are not really serious yet about killing off inflation.

That could set us up for a super cycle of unusual magnitude. Markets will eventually correct, albeit from even more extreme levels.

To be sure the FED is very clever with all their credit facilities but it is not clear continuing to blow up serial bubbles in a variety of markets is longer term a good thing.

All these new sources of liquidity certainly complicate matters in figuring out exactly what the FED is doing, and it should be clear to the reader that things are more complex than just following press reports that the FED is tight with money.

The cost of money is one thing, but the supply of money is another.  In summary, pay less attention to what the FED is saying and more attention to what they are doing.

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