Here Comes Deflation
- MAC10
- 39 minutes ago
- 3 min read
Investors are aggressively positioned for rate cuts, because no one told them that rate cuts in a depression are not bullish. On Wall Street there can be no such thing as a reason to sell stocks.
First off, let's start with the definitions for inflation versus deflation because people generally get hung up on these definitions based solely upon their own personal experience. By inflation I mean an economic scenario in which prices in the economy are rising faster than middle class wages, thereby causing a fall in the standard of living. By deflation, I am referring to mass unemployment in which the middle class is going bankrupt en masse - which is somewhat worse than inflation, when you think about it.
But for now it's bullish:
Last week Powell teed up another rate cut for next week's FOMC due to the imploding job market. And he also made clear that inflation is still rising thereby constraining the Fed from aggressive easing. Which means they are not easing enough to help the job market:
"Federal Reserve Chair Jerome Powell signaled Tuesday that downward pressure on the labor market means there is more room for further interest-rate cuts."
"The downside risks to employment appear to have risen.”
"Markets rallied on the news"
Indeed.
Here is where it gets interesting. A week ahead of next week's FOMC and the massively crowded inflation trade is spontaneously imploding despite an almost 100% probability of a rate cut.
What we are seeing right now in precious metals and commodities is full scale liquidation:
If the Fed is almost 100% certain to cut rates again next week then why is gold imploding?
It's because the inflation trade was merely an end-of-cycle headfake deja vu of 2008. And now the economic brakes have been slammed on and the inflationists are going through the windshield:
Let's not forget that this entire stock market bubble is predicated upon MASS job replacement:
"From tech to airlines, large global companies have been slashing staff as the real-world impact of artificial intelligence plays out, spooking employees. But critics say AI has become an easy excuse for firms looking to downsize."
Companies expect ROI from their gargantuan AI investments. In addition, as the economy implodes they can use it as a convenient excuse to reduce headcount, whether AI is actually useful or not.
Either way, AI is a profoundly DEFLATIONARY technology.
Barron's conveniently summarized the rate cut bull case this past weekend, but as we will see below, they left out a few pertinent details, such as the renewed banking crisis. Which is NOT different this time:
"What’s different this time—and I write this acknowledging the freight that phrase carries—is that previous crashes were preceded by tight Fed policies. But the central bank began lowering its short-term interest rate target more than a year ago, for a total of 1.25 percentage points."
If you knew nothing about 2008, you would believe Barron's. But here's the problem - in this cycle the Fed tightened the exact same amount as they did in 2007. And rates were coming down FASTER in 2008 than they are currently, when banks final imploded.
Now look at this chart of Zions Bancorp one of the banks that blew up last week. Here we see that the initial bank sell off in 2007 corresponds to the bank run in 2023. Then there was a BIG short covering rally during which the Fed paused, just as they paused this year.
Everyone thought the worst was over, including the Fed. Just as everyone thinks this second bank run is no reason for concern.
Then along came the Lehman meltdown in October 2008.
The REAL difference this time for the record --- is that rates are actually much HIGHER now than they were during Lehman (red circle, lower pane).
Over this past weekend I did some more research on this nascent bank/credit crisis and found that the major source of problems lies in loans that chartered banks made to "NDFIs" which means Non-Depository Financial Institutions. These are the various "shadow banks" aka. hedge funds and fly by night lenders, that filled in the gap after 2008:
"Rules put into place after the 2008 financial crisis discouraged regulated banks from making many types of loans, from mortgages to subprime auto, leading to the rise of thousands of non-bank lenders. Moving riskier activities outside of the regulated bank perimeter, where failures are backstopped by the Federal Deposit Insurance Corporation, seemed like a good move."
It seemed like a good move to shift risk to a new group of intermediary companies YET continue to have depositor money flowing through those entities to non-collateralized junk borrowers. It was a "good move" because banks could pretend they were making "AAA" rated loans.
What we see below is that when Trump got elected loans to NDFIs sky-rocketed.
Another good move towards imminent deflation.
