Rational Exuberance

Powell is the new Greenspan.

It was Fed chairman Alan Greenspan who began the legacy of bailing out the stock market at the first sign of trouble. And then he famously claimed in 1996 that the nascent DotCom bubble was a function of "irrational exuberance". Actually, it was very rational exuberance, because it was predicated upon the belief that the Fed would always bail out markets. The next "test" of the rational exuberance hypothesis came in 1998 with the Asian financial crisis/LTCM meltdown. Right on time, Greenspan was there to forcefully cut interest rates which set-off the infamous Dotcom melt-up into Y2K. During his tenure, Greenspan created two monetary mega bubbles, the DotCom bubble and the Housing bubble. Then he retired in 2006 and left Bernanke to clean up his mess.

For his part, Powell is committing his third major error in the past three years, his first error was inflating markets too much in 2021 via the Fed balance sheet (QE), then he raised rates too fast in 2022 trapping the entire regional banking sector in the imploded bond market, now he is once again placating markets by talk of ending balance sheet normalization. Which compounds his two prior errors.

Much of yesterday's relief rally was due to a dovish Powell walking back the hawkish interest rate dot plot which pushed rate cuts further out in the year. The Fed has consistently used hawkish interest rate policy to attempt to control inflation emanating from their balance sheet. As I've said before, the balance sheet is STILL far too large and yet the Fed is already signaling to markets that they are preparing to taper asset rolloff. This is another major "bullish" factor that is lubricating markets ahead of the anticipated event. These combined circumstances echo 2019 when the Fed cut rates three times and ended QT. That set of events caused the pre-pandemic melt-up. However, this time around, the mere hint of rate cuts and QT taper is causing the market to front-run the Fed higher.

The net effect is that Powell is now one inflation report away from losing all credibility.

The Fed has never cut rates when financial conditions were this loose:

And the Fed has never cut rates when core CPI was this high, so if they do cut rates in June it's essentially guaranteed that inflation will sky-rocket, imploding markets.

Had the Fed normalized their balance sheet back to pre-pandemic levels, the pandemic asset bubble would have deflated a long time ago. Instead the Fed is now signaling to markets that it's all clear to make the bubble much bigger. The economic consequences of keeping this asset inflation bubble over-inflated for too long is that it has engendered a renewed appetite to onboard debt. High asset prices are mirrored by high debts and the inflationary mentality is to increase debt on the belief that wages will eventually out grow nominal debt.

Unfortunately, what we see now is that personal interest payments (indexed to 2007) has crossed over wages for the first time in U.S. (modern) history.

Personal interest payments (blue) (indexed to 2007):

Average hourly wages (red) (indexed to 2007):