Peak Manipulation: The Federal Reserve's Impact on the Economy

Nov 1, 2022

Peak Manipulation

Kicking the can doesn’t end when you hit the wall…

Anyone who's anyone knows that tomorrow is Fed day, the pre-scheduled meeting when our central bank announces their latest policy decision on interest rates. A 75 basis point hike is a near guarantee, which would bring the overnight rate fed funds rate to 4%.

The big question is what will the Fed signal for the December meeting and how aggressive will the Fed’s tone be?

It’s a sign of how broken markets have become, that the fate of the world economy hinges on the decision of 12 men and women who meet behind closed doors every six weeks to determine how much they will manipulate the amount of money in the global system. Yet, every six weeks we at Brentwood Research have covered the farcical play.

We began our regular writings three years ago to shine a light on the financial engineering that we believed was taking place in our financial system. The full faith and credit of the United States is built on the strength of our ability to finance our spending. As we have discovered, the financial manipulation we were seeking to expose has not diminished over time, it’s crescendoed into a symphony of outright orchestration happening in plain view. It’s also provided us with wisdom.

We have learned that a secret, when made public, loses its power.

Markets that were once determined by fundamentals like revenue and growth are today exclusively about one thing: what the Federal Reserve decides to do with interest rates and their balance sheet. We no longer question why, that’s just how it is.

Before tomorrow’s interest rate announcement is even made, computer algorithms will pre-read the Fed’s policy decision, and within milliseconds, each word and syllable in the Fed’s statement will be parsed by artificial intelligence. Bet the farm that at 2pm EST tomorrow we will witness tremendous volatility as massive amounts of capital buy and sell ‘on the news’ of rate hikes. It will all take place before the spoken words can even get out of the mouth of CNBC’s, Steve Liesman.

Thirty minutes later, at 2:30pm the world will tune in to hear the most powerful man alive, Jerome Powell, reading from a finely tuned statement which will share the message on the direction of Fed’s interest rate policies. Markets will once again gyrate as algorithms move billions of dollars in mere milliseconds. Newcomers watching the event for the first time might be amazed at how the indices begin to look like EKG machines surging up and down signaling a cardiac arrest. For those of us who have been watching, this is the new par for the course.

Shortly after Powell’s prepared statement, the real fun will begin. This is when the world’s most powerful man will go off script and open the floor for questions. This is the most critical moment to the day. It’s when we all discover how good of an actor our lead central banker really is. J-Pow’s performance and tonality will determine the financial fortunes of the global economy.

Does it all sound dramatic, crazy and over the top?

A few years ago, almost nobody was aware of the power of the Fed. Tomorrow the world will sit in awe of their tremendous might. While many market participants now understand it really is all about the Fed, few recognize that the entire show has become a verifiable Ponzi scheme. This becomes critical information for those seeking a preview on what comes next.

For the last seven months, as the Fed has aggressively raised rates to fight the inflation that they themselves caused, and then claimed came out of nowhere and “caught them by surprise,” and, has since helped them “understand how little they understand” about it all, we at Brentwood Research have continued to remind our readers that intentionally raising interest rates into our overleveraged economy would crush stocks and bonds and put our U.S. fiscal situation into a self-replicating death spiral which would crush the economies of the U.S as well as our G7 allies.

We have also been promising the day when the Fed would be forced to slow down, pause, and eventually pivot, and that once that time arrived, we would witness the dollar slip and fall causing precious metals and other tangible commodities to soar.

We believe that moment has arrived. We are not alone it seems. Insiders on Wall Street are expecting a lighter touch from the Federal Reserve tomorrow. Anticipation of imminent Fed easing has been the catalyst which has driven the equity markets higher over the last several weeks.

In October, the Dow Jones recorded its best month since 1976, rising a glorious 14%. The Russell 2000 notched gains of 11%. The S&P 500 rose 8% for the month. The rise in equities over the past week has been further fueled by rumors from high net worth clients at Blackrock, and coupled with recent Wall Street Journal articles from Fed “whisperer” Nick Timiraos, that have driven speculation there would be “dovish language” inserted into tomorrow’s policy decision.⁽¹⁾

Even the most bearish on Wall Street are expecting a shift in Fed tone.

According to Mike Wilson at JP Morgan, the analyst who has been the most prescient in his bearish market calls and who predicted that the S&P 500 would fall to 3200 points in the face of aggressive central bank tightening, has turned short term bullish. In a note published Monday, he wrote; “Indicators including the inversion of the yield curve between 10-year and three-month Treasuries—a recession indicator with a perfect record support a Fed pivot sooner rather than later,” His conclusion was that a dovish Fed could spark a 10% rally this Wednesday.

If you are wondering why the central bank might indicate they are slowing down in their fight against inflation, you may be asking the wrong question. It’s not a message the Fed wants to send, it’s that the pain from continuation and the imminent recession they have already caused, which is now too sharply being felt here at home and around the world, that may force their hand.

Recession indicators are flashing red everywhere.

Back in March, we explained to our subscribers the importance of yield curve inversions. We pointed out that curve inversions occur when central banks raise rates into slowing economies. When this happens the yields on shorter-term bonds rise more than those on longer-dated maturities. The most important inversion, and the one that signals an imminent recession 100% of the time going back to the 1980s, is the spread between the 3-month and the 10-year treasury bond.⁽²⁾ This is one of the primary data points that the Federal Reserve uses for their interest rate calculations, and a harbinger that the Fed has already tightened too much causing the economy to fall into recession.

Where are we now? Yesterday the yield on the 10 yr treasury stood 20 basis points lower than that offered by the 3-month treasury.⁽³⁾ This inversion is a sure sign that the Federal Reserve has made a monumental mistake. It’s one they will need to correct sooner than later. It’s why market experts are expecting a dovish tilt.

The real economy is suffering. Two years ago, while 30-year mortgage rates stood at 2.8% the average price of a home was $395,000. That was when the housing boom took off. It was driven by an aggressive Federal Reserve buying hundreds of billions of dollars worth of mortgage-backed securities. Today the average price of a home is $518,000 and the 30 yr mortgage rate is 7.08%. In 24 months, buyers have seen an increase of $25,000 in their down payments (assuming 20% down) and monthly payments rise from $1298 to $2779. This is causing a steep decline in the housing market.⁽⁴⁾

In an article released yesterday on Bloomberg, citing data from a survey by Boston-based Alignable, more than one-third of US small businesses are behind on the rent.⁽⁵⁾ About 37% of small businesses, which between them employ almost half of all Americans working in the private sector, were unable to pay their rent in full in October. The numbers get even worse for the restaurant industry. About 49% of restaurants were unable to pay their rent this month, up from 36% in September, while 37% of real estate agents couldn’t pay their rent, up from 27% last month.

It’s not just housing and small businesses feeling the pain.

As we know, the Fed’s tightening has caused a large selloff in stocks. The far more important data to watch, however, is not that tracking equities, but rather the performance of the treasury market. The bond market has suffered far more trauma than at any time in the last 244 years. It is well summed up by the chart below which shows that this is the worst year since 1788 for what has come to be known as the “safest’ security in the world; the 10-year Treasury.

While the 10-year Treasury may be considered safe, it’s sure lost a ton of value!

The pain inflicted by the Federal Reserve is not only being felt here at home, it’s being felt globally.

Aggressive rate hikes by the Fed have driven US dollar strength, which in turn, has pressured other major G7 currencies. We continue to export inflation to our allies. This puts the Federal Reserve in direct opposition to other G7 central banks facing inflationary pressures compounded from food and energy supply shortages due to the war in Ukraine. Eurozone inflation recorded a record print this week of 10.7%.⁽⁶⁾ This is significantly higher than the previous month of 10% and indicative of a slowing economy coupled with a more expensive dollar driving inflation.

As if the recession indicators and geo-political pressures weren’t enough, the Fed also has the midterm elections to consider.

While our central bank is intended to be “independent” and apolitical, the reality is that they are politicians nonetheless. There are many who believe, including yours truly, that the Federal Reserve has worked directly with the Biden administration to “front load” rate hikes in an effort to aggressively tamp down prices before the election so that the price of oil and other commodities would fall and allow the administration claim they are they are winning the fight against inflation.

According to Larry McDonald of The Bear Traps Report, Democrats need the market to rise before next Tuesday to have any chance of a last minute Senate save:

“White house officials were knocking on Fed Chair Powell’ door last week. They couldn’t get OPEC to help oil prices lower to support the inflation fight. Now politically, the S&P must move higher ahead of the big event day on November 8th. Midterms are won and lost in the suburbs, where 401k’s are even more important than the price at the pump.”

Taking all of this into consideration, you may be thinking, alright, let’s go!

Time to get bullish on stocks again!

We suggest containing the enthusiasm.

Short-term momentum from a dovish Fed could very well be coming. However, it is not likely to be a great signal that a new equity bull market has begun. While it may allow for the short-term bounce in equities to bounce even higher, we expect the opposite will be true for the longer term. Fed dovishness at this stage is more likely an indicator that we are in serious trouble, and why any pop higher might better be considered a bear market rally than an “all clear” signal.

According to David Rosenberg, founder of Rosenberg Research, the last time the Dow Jones had a month like October was 56 years ago, in January 1976, when it closed at 975 points. Before extrapolating recent momentum as a signal that a new bull market has begun, be aware that one year later the Dow had fallen 3% to 954. One year after that the Dow Jones had fallen another 25% to 770.

One of the biggest indications of additional trouble ahead is when financial manipulation becomes more and more necessary.

Consider for the first time the Fed “losing money” on their bond book. For the last decade, interest rates pegged to the floor have allowed the Fed to earn more on its securities than it has had to pay out in interest on reserves or overnight loans. Net “profit” after covering expenses was $1 trillion over the last decade. Last year the Fed handed the Treasury $107 billion.⁽⁷⁾ Fed Governor James Bullard said, “Now with rising rates, the situation is changing.”

You think?

The central bank Ponzi scheme is imploding across the globe. This week the Swiss central bank also reported losses of $142 billion for the first nine months of 2022.⁽⁸⁾

Consider what this does for fiscal budgets globally. The last 15 years has provided a downhill run as the central bank monetary manipulation scheme worked wonders. Because central banks are no longer able to send “profits” from their rigged bond book over to their governments' Treasuries, more and more deficit spending will be required to make ends meet. Here in the United States, we have received a $1 trillion windfall from Fed profits over the last decade via interest rate maneuvering. We will now face multiple years without the prospect of this free money.

The fiscal situation is dire for the United States.

One of our main arguments for a Fed who sooner than later is forced to pivot, is the leap in costs to service our debts as interest rates rise. For 20 years, from 1995 through 2015 and as indicated from the chart below, the costs on interest remained, on average below $400 billion per year. As of today, the seasonally adjusted costs on our interest payments has risen to $736 billion.⁽⁹⁾

We have also been warning of the impending increase in costs of living adjustments (COLA) made on entitlement spending to cover rising inflation which increased 8.7% this year and will be paid to 65 million social security and medicare beneficiaries. It will amount to an increase of roughly $100 billion of added expense for the coming fiscal year.

Lastly, on the fiscal side, we can anticipate a deduction of between 15% and 20% of tax revenues, the standard loss during a recession.

Less coming in and more going out is now a phenomenon that has been set in motion by a central banking shift from loose to tight and one that all developed countries are being hit with.

This is a major problem for the United States right now. Yesterday it was announced that the Treasury will be forced to issue $550 billion in new debt in the fourth quarter this year. This is a new estimate and $150 billion more than what was previously predicted in August.⁽¹⁰⁾

The Biden administration has been telling us that they have been bringing down deficits and yet we need to borrow an additional $150 billion more than we thought we needed just a couple of months ago?

It sure doesn’t look like we are being told the truth.

Central banks have enacted quantitative tightening. This means they will no longer be supporting the treasury markets with their massive bond-buying programs. It leaves us with a very good question; who is going to buy all of the government debt?

Enter financial manipulation in the most glorious of ways. It’s a telltale sign that a big shift is coming.

On October 21st, Treasury Secretary Janet Yellen said she was “worried about a loss of adequate liquidity in the market, as Treasury supply booms to fund government spending but regulations limit big financial institutions' willingness to serve as market makers.” ⁽¹¹⁾ This is the same Janet Yellen who while Federal Reserve Chair promised we wouldn’t see another financial crisis in our lifetimes. It’s the same Janet Yellen who went before Congress in 2020 and implored Congress to “go big on stimulus” because interest rates were so low.

Are we really to believe she couldn’t see these liquidity funding problems coming?

If so, why then push for these short-term beneficial programs that would end up putting a nail in our coffin in the long term?

A simple reason. Janet Yellen, just as Fed Chair Jerome Powell and every other Fed Governor has learned, that we can always invent new financial engineering to add to the mix.

Ten days ago Yellen posed the problem to the primary dealers responsible for buying and selling our nation's debt. She asked them to come up with a solution. The 25 dealers who were polled for a detailed assessment of the merits and limitations of a buyback program for government securities. When the last financing plan was released in August, the department’s industry on the Treasury Borrowing Advisory Committee recommended further analysis of the issue. The plan calls for the U.S Treasury to buy its own debt.

Say what?

Who is going to buy all of our new government debt?

You read correctly, our very own Treasury.

WHAT?

This is the same Treasury which has the fourth quarter deficit of $550 billion?

That’s correct!

The U.S Treasury is now the most likely buyer of all of the new Treasuries we need to sell to overcome our fiscal deficits in the 4th quarter. The program is financial engineering at its most magical. The Treasury buys longer-dated bonds, which, in turn, will cause the bond market to rally because of their buying. Then they’ll start borrowing again to build up their cash account back toward their magic number of $650 billion.

Who needs a central bank and QE program? Now the Treasury can rig the bond market to buy bonds and force interest rates lower.

Short-term rates today are higher than last year's long-term rates. We are projected to run an even larger deficit in fiscal year ‘23 because of COLA, loss of Fed remittances, and lower tax revenue in general because of recession and falling capital gains. When we then marry that to a Federal Reserve that is actively trying to put people out of work to squash demand it simply doesn’t make any sense. If we were running a surplus, sure. But we’re not by a long shot.

Who in their right minds would do such a thing?

The answer is far more simple once we recognize the truth.

Manipulation is the way.

There are those that are calling the Treasury proposal genius. It could allow for the Fed to raise interest rates to 4% while at the same time increasing necessary liquidity and without crashing the stock market, something nobody previously thought possible. It’s a magnificent solution to the near-term issues of bond market liquidity. The program will keep bond yields from surging higher than they already have, and will likely have the same impact on the stock market as QE did.

The best part? The simple consideration of the program has already lifted equity markets. It’s all happening prior to the election. Markets rising into midterms is what the Democrats need, right?

Except for one major problem.

This program will increase the Treasury's net interest costs, which are rising towards 1/5th of total tax receipts in order to provide short-term liquidity to capital markets. In other words, we are willing to weaken the financial footing of the country to keep the stock and bond markets afloat. This is not far from having the Treasury outright buy stocks and bonds in the open market, because that’s exactly where the cash is going to end up.

We see it as a naked political move to keep markers afloat and make the economy not look so bad for John and Jane Doe on Main Street, who have seen their 401ks crushed this year.

All at the risk of bankrupting the country.

Who cares about the future? The only move is to continue to kick the can.

Would we expect anything less from the very folks incentivized to see bond yields come down?

It’s not rocket science. When you poll a bunch of primary brokers about the country’s liquidity problems, is it any wonder they come back with a short-term solution that allows them the ability to reset ahead of retail?

If you are wondering, is any of this legal, you must recognize this is the way. It’s the only way.

It’s no different than manipulation that has taken place across our commodity markets. We witnessed trades reversed in the nickel markets when a whale who had taken a giant short position was permitted a do-over on his massive shorting of nickel. It’s no different from the naked shorting that has happened with JP Morgan and other banks' open manipulation of the spot prices of silver.

It’s no different than when we release millions of barrels of oil to suppress the oil price all in an effort to put the administration in a better position to win the midterm elections.

Kicking the can down the road doesn’t end when you hit the wall, it ends when you break your foot.

What does it all mean for gold prices you may wonder. Gold prices have fallen for seven consecutive months, the only time we can find in history that this has occurred. Notice the seven monthly red candles in the chart tracking the spot price of gold.

We cannot guarantee a softer Fed tomorrow, but it’s on the horizon, and a lot sooner than anyone expects. When the pivot comes, the dollar will fall and gold prices will launch.