In this Era of Inflated Asset Prices, Can the Fed Raise Rates without Causing Financial Mayhem?

Wolf Richter on the Keiser Report.

The Fed is trying to accomplish a soft landing — hence the extraordinarily slow rate hikes — but our history with soft landings is very spotty, and there has never been more debt than now:

Investors in the corporate bond market, particularly in junk bonds, are still blowing off the Fed. But not much longer. Read…  Corporate Bond Market Gets Ready for Big Reset

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  25 comments for “In this Era of Inflated Asset Prices, Can the Fed Raise Rates without Causing Financial Mayhem?

  1. Steve Mapes says:

    Given the tax cuts and potential of an infrastructure bill with the Fed exiting QE, who is going to be buying all these new Treasuries, Europeans/Japanese to get a higher yield than their own sovereigns and atwhat rate will 10 years have to get to, to absorb all this additional debt.

  2. Gandalf says:

    To answer the title of this article, the obvious answer is “NO!” Which is why I still seriously doubt that the Fed will follow through completely with its QE off-loading. We are rapidly approaching the 2018 elections, and you-know-who and his Twitchy Twitter Thumbs (the 3T’s!) are not going to take lightly to the stock market tanking because of anything the Fed does.

    Which raises the Big Question – how long can this magical asset levitating act continue if the Fed does not off-load the QE and raise rates significantly?

    • walter map says:

      “how long can this magical asset levitating act continue if the Fed does not off-load the QE and raise rates significantly?”

      For so long as the financialization sector can continue to cannibalize the real economy, or until the peasantry starts getting huffy about getting put out on the tiles, whichever comes first. About eight years, give or take. My people are going to be furious, by the way, when they find out I’ve let this particular cat out of the bag, but they should be somewhat mollified by the knowledge that almost nobody will take it seriously. Of course, other events just might accelerate the schedule, but those are things as unpredictable as, well, you know.

      “Can the Fed Raise Rates in Era of Inflated Asset Prices, without Causing Mayhem in the Markets?”

      Yes, but not much, not enough to normalize rates. Asset prices are inflated, after all, in large part, because rates are too low. It’s mostly what’s keeping them levitated, along with the above-mentioned cannibalization.

      Duckman: we need him now, more than ever.

  3. KPL says:

    20:39 – Fed backs off everytime market falls
    20:49 – Crooks at the central banks

    Kaiser says it as it is. The crooks at the central banks are the monetary terrorists running the world.
    We have given the keys of our house to these crooks and it is kind of silly not to expect them to clean it up.

    Unless the central banks are dismantled or alternatively power significantly curtailed, we would be living in a world of ZIRP and NIRP for decades, because any time the rates go up, the markets will crash and the crooks at the central banks will run to rescue the banksters by screwing the savers, retirees, pension funds and prudent people of the world.

    At this late stage in the game there can be nothing but hard landing or ZIRP & NIRP for as long as you can see.

  4. William Smith says:

    Great interview. It should be mandatory viewing for everyone (in place of the baseball or football game) with a follow up explanation of what certain things mean. Such as “Ponzi scheme” and “printing money” etc.

    In maths there are certain “trapdoor” functions which can’t be reversed; such as multiplying two long prime numbers together. It is impossible to figure out what the two initial multiplicands were. This is the basis of encryption and “crypto” things. Those crooks in the central banks have made a trapdoor financial transaction (free money) which now can’t be unwound. You can’t put the toothpaste back in the tube (as one president once said). I seem to gather that the gist of the interview is that nobody can figure out what the correct numbers are to restore things back to the way they were, so we are all stuffed when the whole sh*t show blows up (as any numbers they try will be wrong). The final result will be a big mess with the central banksters ending up with toothpaste all over their hands and everyone else with rotten teeth.

  5. timbers says:

    “Can the Fed Raise Rates in Era of Inflated Asset Prices, without Causing Mayhem in the Markets? ”

    Consider this in response the question: Since the Fed began it’s extremely slow interest rate increases, it’s possible to argue overvaluation has increased.

    This might suggest the answer is not only “no” but that in fact the decision by the Fed to be so unusually slow, has increased not decreased the likelihood of mayhem and a greater financial bubble than had it moved at normal speed with normal sized interest rate increases and faster reverse QE.

  6. Phil says:

    Wolf, is it possible that the fed is raising interest rates slowly this time to not allow the inverted yield to take place? Throughout history when this happens a recession follows. People are more aware of this now so by moving slowly while monitoring the 10-2 yield, the charts won’t show a recession coming. If they would have raised rates more drastically like they have in the past, we would have an inverted yield right now.

    • Wolf Richter says:

      This time around, the Fed has a tool it never had before to fight an inverted yield curve: the securities on its balance sheet. It can threaten to sell them outright into the market, and it can then actually sell them into the market. This would freak the market out, and long-term rates would shoot up, which would steepen the yield curve.

      So if the Fed wanted to, it could hike its target range for the fed funds rate more quickly and at the same time sell the securities on its balance sheet. This would keep the yield curve steep by pushing up rates across the spectrum. But no one would be ready for the consequences, given the huge amount of debt in the system.

      • Good point and steepening the yield curve gives solace to the banks, and I think the Fed knows this, they can handle a “financial crisis” better than a “market” crash or an economic downturn. Their reflation efforts since 08 have done a phenomenal job of restoring prices, so “financialization” of assets is here to stay. The Fed raised rates into the teeth of the mortgage bubble, and they are doing so again, because they have the magic bullet. Everyone can see the magic bullet, so markets blow the Fed off and the Fed builds a moat around the banks, but they know they can reflate, volatility is the new norm.

    • Rcohn says:

      Raising short term rates has NO DIRECT effect on longer term rates.

  7. David Young says:

    I think that the FED is self-serving. I wonder if they have perceived that the public will object largely to a giant bail-out if they (FED) have losses, so they are now trying to unload some assets (QT) before the value of bonds tanks too hard. They are the smart money offloading some bonds at the top?

    As for why they are raising rates, the bubbles are truly getting scary. Enough is enough.

    • Alistair McLaughlin says:

      The Fed will never require a bailout. It owes no money. It is owed trillions (the assets on its books). Even if many of those defaulted, the Fed would carry on, because the Fed and the Fed alone controls the printing of money, and can create money out of thin air if needed. Such an entity, by definition, will never need to be bailed out.

      • James Levy says:

        Technically, your statement is incorrect: the Treasury could create money by, say, physically printing money or by arbitrarily doubling the size of the refund checks it is cutting right now. For the first, it wouldn’t need to do a thing. For the second, it would have to issue more Treasury Bonds, but as it has never had a problem selling T-bills once in its history, as Mark Blyth likes to point out, this would not likely be a problem (although if they issued enough they would have to up the rate of return to get a quick and easy auction).

        The powers of the Fed are partially real, and partially a manifestation of the abdication of key powers by Congress and the Treasury. Congress chartered the fed, and can change that charter any time they like. It’s just that that would entail taking responsibility for something important, and like war, Congress want’s no part of such responsibility.

        • Alistair McLaughlin says:

          As poorly as independent central banks have performed over the past decade, the last thing we want is for legislators to take direct control of central banking. Nearly every politician who has ever lived has a low interest rate bias. If you think ZIRP is bad (and it is), just let a body that depends on re-election every two years decide monetary policy.

          Don’t confuse the general consensus in comments sections like this one with the views of the wider population. We are a tiny minority. The vast majority of the population in any country would NEVER vote for higher interest rates, and would gladly vote for a politician promising 0% loans and mortgages. Having an independent central bank is our only hope for a return to responsible monetary policy. We’ve had it before. It can be had again.

        • Gandalf says:

          “it has never had a problem selling T-bills once in its history”

          – that’s because we are living off the legacy of our big victory in WWII which resulted in the dollar becoming the reserve currency of the world. People, companies, banking institutions, entire countries buy our debt and trade it on the free market because of that.

          Before and during WWII, the world was very different. The European colonial system divided world trade into closed trading blocks, and the debt of nations, especially the U.S., was not so liquid.

          In the book “Flag of our Fathers”, it is recounted that late in the war, the US Treasury was staring at a monumental hole in its finances to fuel the war effort. Taxes were already up to 90% for the wealthy, and still there was not enough money coming in.

          The newly minted Marine heroes of Iwo Jima, made famous by the flag raising ceremony, were taken off the combat line to join a War Bond Rally tour, to sell US debt to the American people (three had already been killed in action. Two of the six were mis-identified from the photo for years).

          And that was how US debt had to be funded during the war, when the world financial system was locked up by the war, and countries could only count on the wealth of their own people to fight the war.

          I am reminded of this by recent articles about Xi Jinping of China getting rid of term limits to enable him to become President for Life, much like Putin. Xi had earlier laid out a vision for China to become a world dominant military power by the 2035-2050 period. That’s only 17 years away.

          China helps fund our debt for now because they need our money and our trade and our technology and so far are unwilling to test our military power. Japan and South Korea fund our debt because they need our money and our trade and the military protection we provide them. So do a great many other countries and financial institutions – they respect our economic and military power.

          In the end, economic power always comes from military power, and we are living off the legacy of the biggest world changing military victory in human history.

          If we don’t protect that legacy, we’ll end up like the Romans, who, in the end, had degraded so much as a society and as a military power that they were unable to keep the barbarians at the gates from sacking their city.

  8. DK says:

    The correlation of rate hikes leading to a recession is pretty strong. If we assume this is a “given” , then the only question is “at what level will this trigger a recession?”

  9. Drango says:

    We have a central bank that obsesses about the stock market, but said nothing when millions of working class jobs were shipped overseas due to foreign manipulation of the dollar. Kafka should have written a story about how we all woke up one day to find the cockroaches had taken over the Fed.

    • James Levy says:

      If you back to the Plaza Accords the US government has had no problem futzing with the value of the dollar (hell, Nixon did it on an epic scale when he closed the gold window and left all our creditors holding fiat money). Blaming everything on evil others is a bit unconvincing when the US controls the IMF, World Bank, and effectively wrote GATT and the WTO. Whenever the costs, as opposed to the benefits, of holding the global reserve currency are pointed out, too many Americans whine and demand, like 5 year olds, to eat their cake and have it, too.

      Hegemony’s a bitch.

      • Drango says:

        Hegemony means never having to say you’re sorry. If the wheels are turned on trade surplus countries, we’ll see who does the whining. And if the Fed keeps raising rates as Wolf says, there will be some serious howls coming from overseas.

  10. raxadian says:

    When zombie companies and zombie unicorns have debts measured in billions or maybe trillions there is no way even a minimun rate hike won’t ruin them.

    Funny enough most of these zombies won’t even exist today if it wasn’t because of the infamous “0% rates” from a few years ago.

    So my answer is “maybe”.

    • James Levy says:

      My great fascination is with the unreal boondoggle of shale oil, a technology that has been around since the 70s but was always uneconomical until $140 a barrel gasoline followed by free money from the Fed. Most of those “plays” have been uneconomical from the moment the first rig went up (some few aren’t, but they are not what is driving this speculative boom). Under “normal” conditions, say 5% interest rates and $75 a barrel oil, 90% of these wells would be written off. So how seriously are the boys and girls at the Fed watching this industry, built on sand, as they raise rates? And can the global economy function with oil at $100+ dollars a barrel, which is what you would need to make the solid majority of these “plays” as profitable as conventional West Texas wells? The number of variables now in play boggles the mind.

      • Gandalf says:

        Eh, I keep pointing this out, but nobody seems to be listening. Shale oil used to need $100/barrel oil to cover the cost of production, but, like all technologies, has matured and gotten way cheaper, and is profitable at as low as $25-30/barrel. The boom continues not because of cheap funding, but because …. gasp …. it’s actually become possible to make real money drilling for shale oil at current world oil prices.
        When the Saudis dropped oil prices to below $50, a lot of shale producers went bankrupt and the big majors like Exxon and Shell pulled out of shale oil. The survivors figured out how to do shale oil cheaper. That’s just Economics 101.
        Exxon and Shell have since gotten back into shale oil in a big way. Now, there are hucksters in the oil business for sure feeding off that cheap money, but Exxon and Shell are not huckster companies.
        Go look it up on Google. It’s all there.

  11. Kiers says:

    Insistence on the raising of rates only proves one thing: the US will HAVE TO concomitantly move to a trade surplus to make it work, Which means Capital Account deficit, which also seems to tie in with Brexit….it all unfolds slowly on us sheeple….the plans laid in advance.

    You think it can happen with the salesman-in-chief at the wheel? They’re giving it the college try as best as the illuminatti can!

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