Month: October 2021

Authored by Tom Ozimek via The Epoch Times,

White House economic adviser Jared Bernstein told Fox News in a recent interview that inflation is likely to stay elevated longer than previously expected.

Bernstein told the outlet that he thinks the rate of inflation will come in at around 4 percent for 2021, before falling to 2.3 percent in 2022. He did not say when, precisely, he expects the rate will tick down next year, but noted inflation would likely stay high into the middle of next year.

His expectations closely track the Fed’s most recent predictions. While Bernstein did not specify which inflation measure he was referring to, his estimates are in line with the most recent Personal Consumption Expenditure (PCE) inflation projections from the Federal Open Market Committee (FOMC), the Fed’s policy-setting body.

After its most recent Sept. 21–22 meeting, the FOMC issued a revised set of economic projections (pdf) that estimate the PCE inflation rate at 4.2 percent for 2021, a sharp upward revision from June’s projection of 3.4 percent.

For 2022, Fed policymakers expect PCE inflation of 2.2 percent, up from an earlier projection of 2.1 percent.

However, the 18 members of the FOMC varied in their predictions, ranging in next year’s PCE inflation estimate from 1.7 percent to 3.0 percent.

Bernstein, like Fed officials and many economists, blame supply-side disruptions for the bulk of the recent inflationary spike. When supply chain dislocations get ironed out, inflation will subside, he argued.

Some economists have warned of the growing risk of stagflation—where economic growth falls while inflation stays high.

Economist Nouriel Roubini, known for his gloomy-yet-accurate forecast of the 2008 financial crash—a prediction he made at a time of peak market exuberance—warned in a recent op-ed that the global supply chain crisis, combined with high debt ratios and ultra-loose monetary and fiscal policies, threatens to turn the “mild stagflation” of recent months into a full-blown stagflationary crisis.

Stephen Roach, former Morgan Stanley Asia chairman, on Wednesday became the latest high-profile economist to sound the alarm on the risk of the United States facing 1970s-style stagflation. Roach thinks the energy price spike is inflicting major damage to struggling supply chains, pushing up the risk of higher price growth even if the economy slows down.

While Fed officials maintain that the current bout of inflation is temporary and will abate once supply chain dislocations ease, they’ve acknowledged that inflation has been higher and longer-lasting than they previously believed.

New York Federal Reserve Bank President John Williams said on Sept. 27 that consumer expectations for what the rate of inflation will be several years down the road remain “well-anchored” at around the Fed’s 2 percent objective, though he said there are upside risks and a “great deal of uncertainty” around the inflationary outlook.

As we noted earlier, traders have been at a loss to explain today’s sharp 10% move higher in bitcoin and the broader crypto universe, with a variety of explanations being proffered including Jerome Powell’s comments Thursday that the central bank had “no intention” to ban cryptocurrencies, others pointing to Chamath’s statement that Bitcoin has “effectively replaced gold”, some pointing to Visa’s announcement on Thursday outlining for what it calls a “universal payments channel” that will facilitate CBDC transactions and which will be deployed on an Ethereum layer, while the more technical traders cited price levels such as moving averages that are closely watched by technical analysts.

And while it is likely that today’s burst higher in the crypto sector is some combination of all of these, we can now add one more reason for near-term crypto optimism: amid rampant speculation that the US Treasury and/or regulators seek a permanent crackdown on stablecoins such as Tether and Circle’s USDC – which has for a long time been viewed as the weakest link in the crypto ecosystem, with many speculation that it facilitates currency flight out of China – moments ago the WSJ reported that the Biden administration is considering ways to impose bank-like regulation on the cryptocurrency companies that issue stablecoins, including prodding the firms to register as banks.

Just as importantly, the administration is also expected to urge Congress to consider legislation to create a special-purpose charter for such firms that would be tailored to their business models, the WSJ sources said.

According to the WSJ, the moves “are intended to address regulators’ fears that stablecoins—digital currencies pegged to national currencies like the U.S. dollar—could fuel financial panics and need to be more tightly regulated.” This would take place in parallel with the Financial Stability Oversight Council deciding whether to designate stablecoin activities as systemically important.

From the administration’s perspective, it would be preferable if Congress were to impose or authorize a bank-like regulatory framework for stablecoins, as well as a series of investor protections for cryptocurrencies. If Congress doesn’t act, and its other recommendations go unheeded, the administration wouldn’t be reluctant to use FSOC, one of the people said.

And since it appears that bank-like regulation for stablecoins is now inevitable, it is also virtually assured that stablecoins will be deemed systematically important.

Which is actually great news for both stablecoins, and the greater crypto ecosystem, because it means that instead of crushing this vital link between fiat and digital tokens and seeking to snuff out cryptocurrencies at the root – as China has done – the US will instead push aggressively with a regulatory approach, one which most industry participants had already expected.

Indeed while at present many stablecoins are lightly overseen at the state level, some companies, such as Circle, have said they are seeking to become banks. And at least some members of Congress, such as Sen. Cynthia Lummis (R., Wyo.), have recently signaled that stablecoins may need to be regulated in this manner.

“It may be the case that stablecoins should only be issued by depository institutions” or by firms regulated as mutual funds, Ms. Lummis said in a Senate speech this week.

One company – which is already a bank and is certain to have a substantial advantage over its peers when the new regulation is implemented – will be Silvergate Capital, a bank which as Morgan Stanley dubbed earlier this week when it initiated coverage dubbed “a crypto bank like no other.” Furthermore, the fact that Silvergate will be the issuer of Facebook’s upcoming stablecoin, Diem – and one can be absolutely certain that once cleared, Facebook will seek to not only capitalize the ongoing shift to digital currencies but monopolize as much of it as it can – only assures that when the administration does move on with its treatment of stablecoins, SI will be one of the biggest winners. And, with a market cap of just $3 billion, we fully expect the company to be acquired by either its JV partner Facebook or some other major bank at multiples of its current market value.

Via Into The Swarm blog,

“I like these calm little moments before the storm. It reminds me of Beethoven. Can you hear it? It’s like when you put your head to the grass, and you can hear the growin’, and you can hear the insects. Do you like Beethoven?”  

– Léon.

Down the Market Hole

In his famous book 12 Rules for Life: An Antidote to Chaos, Canadian clinical psychologist Jordan Peterson argues that positive feedbacks are one of the main drivers of diseases such as alcohol addiction:

“Imagine a person who enjoys alcohol, perhaps a bit too much. He has a quick three or four drinks. His blood alcohol level spikes sharply. This can be extremely exhilarating, but it only occurs while blood alcohol levels are actively rising, and that only continues while the drinker keeps drinking. When he stops, not only does his blood alcohol level plateau and then start to sink, but his body begins to produce a variety of toxins. Withdrawal starts as the anxiety systems that were suppressed start to hyper-respond. A hangover is alcohol withdrawal. To continue the warm glow, and stop the unpleasant aftermath, the drinker may just continue to drink until all the liquor in his house is consumed, the bars are closed, and all his money is spent.”

The fact that this concept also applies to capital markets should not as a surprise, especially after years of intense dip buying activity. In fact, feedback loops have been highlighted by econophysicists and behavioral finance experts for a while. As Robert Shiller wrote in 2017:

“When speculative prices go up, creating successes for some investors, this may attract public attention, promote word-of-mouth enthusiasm, and heighten expectations for further price increases.”

Since March 2009, equity investors have realized that any correction would finally lead to a positive outcome. At the beginning, it took a long time before a positive emotion emerged. But as the bull run accelerated, the reward came faster and faster. Today, all dip – even micro-dips – are almost instantaneously bought by a bunch of traders driven by Pavlovian reflexes, leading to quick gains and reinforcing the power of positive feedback loops.

As a result, the market is starting to feel invincible (again). When that happens, the system becomes more vulnerable to even small shocks, as most participants hold a direct or indirect short position on volatility, and it does not take more to derail the machine.

People always wonder what could trigger a correction. But that question may be secondary, as several research papers emphasized the role of endogenous catalysts in large fluctuations regimes (see “Exogenous and Endogenous Price Jumps Belong to Different Dynamical Classes”). Therefore, what really matters is the market positioning in terms of risk management, and especially its tolerance to a jump in volatility.

The 1987 crash is a good illustration of the role played by endogenous dynamics and the risk associated with out-of-control positive feedbacks.

Indeed, that severe fall was mainly due to internal forces, as participants had become highly correlated to each other. When prices started moving the other way, a negative emotion instantaneously propagated through the system, leading to the agglomeration of seller flows and a collapse in liquidity.

The outcome was the perfect illustration of Benoit Mandelbrot’s “Noah effect,” i.e. a discontinuous adjustment of prices rendering ineffective protection mechanisms such as stop-loss orders.

You should never forget that the trend is your schizophrenic friend, meaning that sometimes it can disappear without warning.

Red Queens Narratives

The US stock market has become entirely dependent on the continuation of those positive feedback loops which have been exacerbated by the Fed’s desire to fuel the rise in financial assets. This is the reason why Jerome Powell has no choice but to assert that inflation will magically disappear in a few months, because any serious hawkish tone could lead to a brutal unwinding of positions.

From a behavioral perspective, the ongoing bull market mostly relies on the intersubjective idea that money printing will never end, and that quantitative easing is extremely positive for stocks (which is not necessarily the case in economic terms, but that is another debate). To learn more about the importance of narratives in finance, please read “Narratives Matter, Until They Don’t: Introduction to the Intersubjective Markets Hypothesis.”

As long as the market adheres to the “transitory inflation” narrative, then the Fed can continue to play that tricky card a little longer. But everyone should be careful, because as soon as the tide turns, the reversal may be far too brutal given the extreme complacency of investors.

As we reported earlier this morning, Merck has released what experts say are “extremely positive” test results for a COVID anti-viral that cuts risk of hospitalization in half, while also dramatically reducing the risk of death. The data were so profoundly positive that an oversight board ended the trial, claiming that withholding the drug from patients in the placebo group would be “unethical”.

Merck says it can deliver 10MM doses of the new drug, called Molnupiravir, by the end of the year, by which it should be approved by the FDA and possibly foreign regulators as well (the wheels of bureaucracy are reportedly turning as quickly as they can).  Merck is submitting an emergency application for authorization of the drug, and we may see it in use during the next two weeks. The regiment is 2 pills a day for 5 days, and it’s most helpful within 5 days of infection.

The news has sent US stocks into the green for the day, while shares of Merck briefly soared as much as 12%.

Meanwhile, shares of Moderna are really taking it on the chin, and have fallen by more than 10%.

After failing to foresee the potential “game-changing” impact of the new drug, Wall Street analysts are scrambling to interpret what Molnupiravir will mean for markets and the economy.

In a roundup of commentary from Bloomberg, most agreed that the drug would be a “game-changer” for the pandemic, and that it will likely receive emergency use authorization before the end of the year.

Evercore ISI analyst Umer Raffat referred to the pill as a game changer for Covid-19, writing that the data “really is THAT good”.

• Expects oral pills to be a “big deal” in combating Covid with the ease of use and scale of manufacturing being a game changer
• From MRK stock perspective, pipeline should finally start to get real credit – starting with this readout today”

Barclays analyst Carter Gould expects a straightforward regulatory decision for the pill to receive emergency use authorization from the FDA with the data representing a needed win for Merck in combating Covid-19.

• Highlights that the Street had estimated near-zero value for the drug prior to today’s news with Merck set up well to book a $1.2 billion contract later this year.

Cantor analyst Louise Chen highlighted that the data showed consistent efficacy across Gamma, Delta, and Mu variants and said the pill could “change the treatment paradigm”

• “Positive data could clear path to take a slice of an untapped pie in the COVID treatment landscape (multi-blockbuster opportunity in the U.S. alone)”

SVB Leerink analyst Daina Graybosch wrote that the drug could unlock more than $10b in near-term orders and also “represent the best option for bringing the pandemic under control worldwide”.

• Expects approval in the U.S. before year-end with additional supply contracts in the coming weeks

Morgan Stanley’s Matthew Harrison wrote that the data are a significant positive for patients and the broader public’s risk perception as it relates to COVID

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Source: Bloomberg