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No reflation?

David Stockman issues one of the most thought-provoking newsletters I’ve read in years.   He combines his experience in the Reagan administration as Budget Director with his more than 30 years in the investment world, much of it with some of the best-known firms on Wall Street, to present views rarely found elsewhere.

Stockman has constantly written about how the bond houses and hedge funds made billions of dollars front running the Fed in its bond buying quantitative easing (QE) programs.  The front-runners knew that the Fed would be buying bonds, thereby forcing interest rates down and bond prices up.  Further, some central banks bought common stocks in addition to bonds.  Consequently, the front-runners had virtual locks on profits at their trading desks.

But now, the Fed has entered a period of quantitative tightening (QT), meaning that it plans to sell up to $2 trillion of its $4.5 trillion bond holdings.  This will put downward pressure on bond prices.  And, according to Stockman, other central banks are either slowing their QE programs or beginning their own QT programs.  This means less money going into the bond market, causing lower bond prices and higher interest rates (which historically have slowed economic activity).  The bond houses and hedge funds are now off-loading their bond positions, again front running the Fed.

These central banks’ reversals have caused turbulence in the stock market, with the Dow Industrials swinging as much at 1,000 points some days.  Truly, the Fed’s move is a tectonic shift.

Still, the stock perma-bulls do not see a bear market for stocks.  They are still advising “buy the dips,” counting on central bank reflation, a return to QE or, at least, stopping QT.

Stockman’s position on “buy the dips” recommendation: “there will be no rapid reflation or other bailout from Washington.”  I’m not so sure about this.

In my next post, I will present an historic example where a government “reflated” every time its economy slowed, which resulted in the destruction of the currency of one of the world’s best-known countries.  No, it was not Germany’s infamous hyper-inflation of 1918-1924.

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