Looming debt ‘death spiral’ will force Fed to restart money printers sooner: expert

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As the Federal Reserve continues to raise rates in a rapidly slowing economy, macro analyst Luke Gromen warns of a growing risk of a ‘death spiral’ culminating in a default on US government debt which will force the central bank to suspend monetary tightening sooner than expected. markets expect, then re-start full-throttle money printers to resume debt monetization.

Soaring inflation has prompted the US central bank to embark on a path of quantitative tightening, with market expectations – based mainly on eurodollar futures – predicting that the Fed will continue to hike for a while. another six months or so before taking a break.

The Atlanta Fed’s market expectations tracker, which estimates the three-month average federal funds rate using a methodology centered on eurodollar futures, predicts that the Fed will not rise no more than about 350 basis points, or 3.50%.

The last hike is expected to take place at the December Fed meeting, with the tracker then estimating a small and steady decline in the fed funds rate to around 284 basis points by mid-June 2023.

But that consensus view — that the Fed will continue to climb for another six months before pivoting — will face a stark reality check as economic indicators deteriorate and GDP slows, putting pressure on the costs of the servicing debt and forcing the Fed to advance its schedule for a pivot, Gromen argues.

Fed Pivot Much Faster?

Gromen, founder of macroeconomic research and investment firm Forest For The Trees, told the Real Vision Finance program in a recent interview that he believes the Fed’s latest rate hike is just a month away.

“My base case [scenario] is what I think we’re likely to see in US economic data over the next couple of months is likely to bring forward the day… when the Fed is forced to halt the hike,” he said, predicting that “the latest Fed hike will take place by the end of August this year.

A number of economic indicators, with the notable exception of relatively strong labor market data, suggest that the United States is heading into a recession.

Real disposable income, real sales and monthly GDP have all deteriorated over the past three months, alongside signs of cooling in the housing market and a drastic decline in consumer confidence.

The Conference Board’s Leading Economic Index (LEI), which uses a weighted average of 10 indicators to indicate whether the economy is improving or deteriorating, fell for the fourth straight month in June, with the organization’s analysts predicting that a US recession is now the basis Case.

“Amid high inflation and rapid monetary policy tightening, the Conference Board expects economic growth to continue to slow through 2022. A U.S. recession later this year and early next year is now likely,” Ataman Ozyildirim, senior director of economic research at The Conference Board, said in a statement.

Public debt default risk

In the interview, Gromen was asked what factors could trigger a pause in rate hikes by the Fed sooner than consensus opinion about six months from now, and he replied that he Particular stress would likely act in the US Treasury market or credit markets. .

“This [stress] could be as extreme as something we saw in the short term with the spike in repo rates in September 2019,” Gromen said, or it could be as subtle as the Treasury market falling alongside equities.

Gromen added that rising Treasury yields, which move inversely to prices, are “very inauspicious” to the funding status of the US government.

Citing research (pdf) by Brian Hirschmann, managing partner of hedge fund Hirschmann Capital, Gromen said history shows that all countries over the past 200+ years (except Japan) have reached 130% of debt to GDP, which the US briefly surpassed in 2020 – then defaulted on its debt.

“Since 1800, 51 of the 52 countries with gross public debt above 130% have defaulted, either through restructuring, devaluation, high inflation, or outright default,” Hirschmann wrote in his analysis.

Japan is the only example of a country avoiding default despite having public debt above 130% of GDP, although Hirschmann says a Japanese default is “inevitable”.

The public debt-to-GDP ratio in the United States reached 134% in the fourth quarter of 2020, and in the first quarter of 2022 it was 125%, according to data from the St. Louis Fed.

“Debt death spiral”

If GDP continues to deteriorate in the United States and interest rates remain high, Gromen predicts a “debt death spiral” that will make debt servicing costs unsustainable.

“The ability to do austerity in the United States is a total illusion,” Gromen said.

American policymakers had the chance to impose austerity a decade ago, but they failed.

“Failure of leadership on both sides of the aisle in the United States and other Western social democracies means this is what you have to do – if you pump it up, you have to pump it up,” he said. he declared, arguing that the only realistic possibility for the US government to avoid a default is to let inflation soar.

But with soaring inflation imposing a massive cost-of-living squeeze on American households and polls showing inflation has become a major problem for Americans, the Fed appears determined to raise rates aggressively. .

If the Fed doesn’t pivot quickly in the face of a slowing economy, it risks a “huge crisis,” Gromen said.

“It’s going to be inflationary”

In addition to predicting that the Fed will take a break at the end of August, Gromen thinks that by July 2023, the central bank will turn on the money printers and resume its quantitative easing program.

“I think we will be beyond the debate in a year. I think it will already be done. I think it will come back,” he said of the discussions around quantitative easing and the sharp drop in interest rates.

Asked what the Fed is likely to do if it pivots and inflation remains above 4%, the central bank is likely to adopt some form of yield curve control, as in Japan.

“Austerity is going to send this debt death spiral,” Gromen said, adding that Fed policymakers “are really stuck between a rock and a hard place.”

Unfortunately, if the Fed releases its brakes, it likely means inflation will stay elevated, likely above 4%, Gromen believes.

“It’s going to be inflationary,” he said. “It’s going to look a lot like the United States as Argentina with American characteristics.”

“Is this how I want it to be?” No. But again, we had 40 years for our political leaders to be adults – and they weren’t on either side of the aisle. And so that’s what you get.

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Tom Ozimek has extensive experience in journalism, deposit insurance, marketing and communications, and adult education. The best writing advice he’s ever heard comes from Roy Peter Clark: “Reach your goal” and “Save the best for last.”

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