As global markets and economies head into the final stretch of 2022, there’s much ground for concern as current inflationary pains/trends collide with a deflationary recession.

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ith global debt levels risings well past the $300T level in the backdrop of: 1) superficially hawkish central banks raising interest rates to unaffordable levels, 2) the US entering a recession, 3) EU nations flirting with increasing political fracturing and inflationary stress in the wake of 4) backfiring sanctions and 5) an ongoing war in Ukraine, suffice it to say that we have not seen such a precarious macro setting in decades.
 

THE BOGUS/FAILED WAR ON INFLATION

For now, the US Fed is claiming to fight 9.1% (and rising) year-over-year inflation with rate hikes allegedly reminiscent of the Volcker era. Toward this headline-making end, Powell recently raised the Fed Funds Rate to 2.50% in July.
 

From where we sit, however, such rate hikes (6.75% y/y), even if they were to hit the Fed’s targeted 3.8% level in 2023, will have little to zero impact on actually combatting the 9%+ CPI inflation rate. In short, Powell is no Volcker 2.0, and knows all too well that with a US debt to GDP level of greater than 125% in 2022, he is no position to make the kind of inflation-killing rate hikes (1000 bps) which Volcker made in 1980 when US debt to GDP levels were at 31%.
 

NEGATIVE REAL RATES: THE NON-REPORTED REALITY AND PLAN OF BROKE SOVEREIGNS

With $23T of outstanding IOUs (i.e., US Treasuries) floating today, more Fed rate hikes only makes their interest expense more painful to pay. 30% of those UST will soon be repricing at 6.75% y/y higher rates, which will cost Uncle Sam an additional $460B+ in just interest expenses alone 1 year from now, a sum amounting to 12% of US tax receipts.
 

This is not a sustainable (i.e., affordable) policy longer term. Given that US debt levels are far too high to endure the kind of meaningfully sustained rate hikes necessary to defeat inflation, what explains all the hawkish talk from the Eccles Building about using rate hikes to fight inflation?

Our answer is simple: The Fed has no intention to fight inflation with rate hikes. Instead, it privately wants inflation to outpace rates, but just won’t report that openly or honestly.
 

Despite public optics to the contrary, Powell’s real aim is to inflate away chunks of Uncle Sam’s $30T debt pile via a negative rate policy in which inflation rates (far closer to 18% under the 1980 CPI scale than the mis-reported 9% rate) are well above interest rates. Privately using a negative real rate policy (and then fudging the inflation data to publicly hide it), is one of the oldest tricks in the book for debt-strapped nations like the US to debase their currency as a means to paying down debts.
 

As for the headline-grabbing and “tough-on-inflation” rate hikes of 2022, the Fed (like the ECB in July) has only been raising rates in 2022 so that they will have something—anything—to cut when the recession approaching them today becomes deeper and stronger tomorrow.
 

DON’T BLAME INFLATION OR PUTIN OR A VIRUS

As for inflation, it is now increasingly clear among many citizens and investors across the US and EU that the sanctions against Russia have largely backfired and only made an already bad inflationary situation that much worse. Energy costs sourced out or through the Ukraine have crippled consumers in the US in general and the profoundly energy-dependent EU in particular, who continue to see trending declines in Eurozone PMI’s.

German dependance on Russian natural gas has made that country particularly vulnerable to rising energy costs.
 

Despite the undeniable inflationary consequences of expanding the broad money supply by trillions in the last decade, central bankers and politicians in the US and Europe like to pretend that current inflation pains are the exclusive fault of a Russian bully or a global virus. Unfortunately, the real blame for the current inflation sickness belongs primarily to the disastrous monetary and fiscal policies coming out of DC and Brussels since circa 2008.





















 



RECESSION TO FIGHT INFLATION?

Despite taking no public responsibility for the inflationary nightmare in which the West now finds itself, central bankers know that the only real tool left to combat the very inflation which grew from their own money printers will come from the dis-inflationary forces of a recession emanating from their own temporary yet current rate-hiking policies.
 

Alas, since 2009, the central banks gave us inflation with a money printer and will now give us a recession with a 2022 rising rate policy.

As debt costs rise on the wake of central bank policies, manufacturers are already feeling (and showing the pain) as the July ISM Index hits lows not seen since 2020.
 

That’s why we foresee a near-term continuation of slowly rising rates, which will nudge upward until something breaks in the global market economy that is factually far too debt-soaked to endure such rate hike policies for much longer.
 

And if you listen carefully, Powell has effectively confessed as much. After “hawkishly” raising the Fed Funds Rate by 75 bps in July, Powell took a more “dovish” tone the very same day at the press conference which followed.
 

That is, he announced “concern” about “softening growth” (i.e., back-to-back quarters of declining GDP, aka a “recession”) and used classic “Fed speak” about making any future rate hikes more “data dependent.”
 

To us, such language is another way of signalling an inevitable pivot from rising rates, to “pausing” rates, and then eventually, “cutting rates.” In short, we see an inevitable (though not imminent) “pivot” from current quantitative tightening to future quantitative easing once markets and economies begin to bend under the fuller weight of a recession which is now all but obvious.
 

RECESSIONS MAKE POLICY PREDICTABLE

Recessions, moreover, can’t be overcome if rates are high or the currency is strong. For this reason, the eventual QT to QE pivot is all the more foreseeable given the increasingly undeniable reality of a painful recession already knocking on the doors of the US and EU.
 

By extension, the only way to weaken the currency and fight a recession is to reduce, rather than hike rates. This is achieved first by 1) cutting the currently rising Fed Funds Rate (i.e., a “Pivot”), and then later, as demand for sovereign IOUs effectively tanks, by 2) breaking out the money printers to buy those unwanted IOUs with more mouse-click money to keep yields and hence interest rates capped/controlled.
 

In other worlds, the Fed and the ECB will be forced to embark upon the same kind of currency-crushing and desperate Yield Curve Controls (YCC) now evident in Japan, whose Yen, debased by decades of extreme and dilutive money printing, has reached 50-year lows in 2022.
 

Of course, the Yen is not the euro, nor is it the world reserve currency. But neither the euro nor the USD can escape the natural laws of money supply expansion (and debasement), which means they can’t escape a fate similar to the embarrassing Yen.





















 





BOND PAIN OR GAIN AHEAD?

As for the deflationary (or at the very least, dis-inflationary) forces of a looming recession, this will mean slowing demand, falling Fed Fund Rates, a weakening USD and declining interest in both US stocks and bonds, which could send bond yields higher on the UST and other credit instruments.
 

The Fed, however, doesn’t like to see (or pay for) falling UST’s and hence rising UST yields, as rising yields create higher rates which, as argued above, make recessions worse rather than better. Again: The surest way to “cap” and “control” those rising UST yields and falling bond prices is for the Fed to print more magical fiat dollars to buy Uncle Sam’s own debt. Such artificial demand policies are the very definition of Yield Curve Control (YCC), which, to repeat, we see as largely inevitable as we head into 2023.
 

GOLD’S ROLE AND RISE

Unfortunately, YCC costs money which Uncle Sam’s falling tax receipts and quarterly GDP declines simply can’t provide, which means the only option left is the most addictive and most familiar, namely: The Money Printer at the Eccles Building.
 

Similar moves at YCC will be followed by the ECB. More mouse-click money, however, can only mean more currency debasement for the USD, euro, Yen etc.
 

Gold, of course, shines brightest against falling currencies and rising recessions as an historical insurance policy against currencies already burning to the ground—some quickly like the Yen and others slowly like the USD. Fast or slow, West or East, however, the historically-confirmed end-game is the same for this precious metal. That is, it’s not that gold suddenly rises, it’s that currencies are openly failing.   EG

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