Geopolitical Update : FED could shock markets in 1st half 2022
By Christian Takushi, Macro Economist – 8 days delayed & truncated release to the public on 23 Jan 2022
this year promises to be a challenging one for the world economy, financial markets and the West.
In November we addressed Fed policy by highlighting that Powell II is not the same as Powell I. On 16 December we also warned that investors were relying too much on their Fed experience of the past 14 years. Those who heeded our geopolitical analysis were able to protect their portfolios by reducing exposure to growth stocks & duration, and by increasing cash, gold and silver exposures. But maybe it is still not too late to take some protective action. It is clear that one month later our geopolitical-political warning has worked, but in 2022 we need to review our outlook more often than in past years. Even if many of our readers have gone into cash, this is not a time to sell and go away, but to stay active and opportunistic.
Our latest analysis is as usual from the geopolitical-political perspective:
From this perspective I highlight here the most widespread ideas among investors that are at elevated risk ..
- Investors believe the FED will protect them no matter what – Just as it protected them from big extended losses. We believe the FED may have to sacrifice Wall Street in order to appease Main Street. Politics rules FED in 2022.
- Investors believe they face merely 3-4 rate hikes over the next 12 months. In fact they are facing them over the next 6 months. And it might be more aggressive then what they think.
- Most investors believe the FED will stick to the FOMC schedule, because it would not dare to upset markets. But my analysis points to the high probability that the FED could shock markets by raising interest rates ahead and outside of the scheduled FOMC meetings.
Thus, guessing the number of rate hikes is foolish, it is all about impact in 2022. A massive 100 bps hike on January 30th would do much more harm than 3 brave rate hikes on schedule.
- Many investors also believe the FED has had a kind of change of heart – it now cares about inflation, because the latter is hurting especially low income people. This couldn’t be further from the truth. The main reason why the FED wants to raise interest rates to fight inflation is POLITICS. Americans are furious about rising prices and Democrats are on track to lose both the House of Representatives and the Senate to the Republicans. In Washington many Democratic strategists say this is all or nothing now – about the “life or death of democracy in America”. Insiders know that FED independence is a relative thing.
- Many investors think that Covid is responsible for high inflation -The main reason for the current high inflation is central banks and fiscal excesses. Central banks have weakened and distorted the real economy for 12 years by massively disincentivizing investments and promoting speculation. Companies have not invested enough in production facilities nor their proper maintenance. Any kind of disruption would end up in shortages and price hikes.
Although our independent analysis shows the FED wants to stick to its expansionary policies, political reality in Washington has changed and is dictating monetary policy – at least for the first 10 months of 2022. Unlike President Trump, President Biden has doubts about the current FED policy. His party (DNC) is on track to see a terrible defeat at the coming Mid Term Elections and they blame FED Chair Powell and his successors for that.
Democrats want to avert that disaster by all means – which they say may seal off the decline of US democracy – keeping Mr. Trump from taking Congress in November and gain momentum for the Presidential campaign 2023-2024. Yes, although Mr. Trump is not officially running the GOP, he commands the loyalty of the vast majority of dedicated GOP voters.
Realpolitik, US style
I am convinced President Biden confirmed Mr. Powell at the helm of the FED under the main condition that he fights inflation in order to give the Democrats a chance to defend Congress this coming November 2022. Officially it will be about protecting low income families. But I don’t buy the latter – the FED knows inflation is running way above its key interest rate for over a year, but it has done nothing – it only talks about eventually raising rates. Powell may not be able to control inflation, but the FED can effectively help reduce the massive wealth gap that the FED has created over the past 13 years. A market shock would do that and this would help the Democrats.
If Powell attacks inflation and wealth gap, the elections could become competitive in key states.
But I wouldn’t rule out that if Mr. Powell fails to contain inflation and the fury of voters, President Biden will de facto fire him, i.e. orchestrate a change at the helm of the FED. After all Mr. Powell is neither a trained economist nor a seasoned banker – and there are voices that already are blaming the “FED’s being behind the curve” on his lack of deep knowledge and command of the complex monetary issues at hand. Powell waiting too long on raising rates could prove disastrous if Russia invades Ukraine, shocking markets and leaving the FED with no room to lower rates.
After several decades of unprecedented freedom and the ability to use US monetary policy to advance the consensus agenda of G7 central banks, it is a tough reckoning for the FED to be under the tight scrutiny of the US President, something the latter has somewhat delegated to Ms Yellen at the Treasury. The FED remains of course officially very independent – that is how it should look like. Just like the strong NATO image US and European leaders strive to project.
Back to financial markets
Markets are unprepared for what is coming. Misled, they are focusing on guessing the number of rate hikes – which is not really the issue in 2022. Here I state some of the flawed tendencies I still see as of today January 15th 2021 among investors …
- Most investors are fully invested
- Most investors hold very expensive and speculative assets, and tell me there is no alternative to equities
- Most investors hold little cash, because it doesn’t pay off
- Investors have been increasingly replacing Gold (and Silver) with crypto currencies rather than using both as complementary assets
Let’s recap .. rates could overshoot
We believe the FED is only deviating from its script, because of massive pressure from President Biden. Americans are furious about rising inflation and they are on track to hand over both the House and the Senate to Republicans this November. Thus, barring a surprise event, the FED has to shock markets within the next 6 months, not 12 months. To wait for a Russia invasion to cool down everything could really make things much more complicated for Powell. This “I wanna be sure and wait” by chair Powell could backfire terribly: Russia could invade and send Western economies into recession, while energy prices skyrocket and push food prices even higher. I say this, because Moscow has levers in the Middle East to reinforce the Oil price shock.
Moreover, as someone that has been in the investment world since 1989 I feel that the FED may want interest rates to overshoot in the 1st half 2022 to reconcile all these political, monetary and geopolitical factors! That is why I’d expect a shock, a surprising rate hike outside of the FOMC schedule. I personally tip for a move in January-February. What matters most in 2022 is the degree of surprise. A massive overshooting would allow the FED to break the self-fulfilling inflation psychology .. and later to have the “room” to steer rates sharply lower in order to stimulate the economy and regain somehow the favour of angry investors.
After the shock – we could face a weaker economy
After taming inflation the FED will want go back to over-stimulating the economy and printing money. Without excessive liquidity and stimulus, Western economies would otherwise shrink. And they could shrink fast for three major reasons. Let’s list them ..
- Western societies are ageing fast and without massive immigration they are poised to shrink, which would be no failure, rather simply natural. Thus, balance sheets have to shrink as we need less of almost everything
- Most assets in Western economies have been artificially inflated over the past 22 years by central banks – and aggressively so. Not only that, our policy makers also inflated consumption with cheap and massive credit. Thus, while our consumption needs to shrink back to healthier and sustainable levels, the prices of our stocks, bonds and houses may also have to shrink after having been artificially boosted over the past 20 years.
- The monetary policy of Zero-Interest-Rates of the past 14 years has created inflation within asset prices, but it also has seriously debilitated the production capacities of our economies. Policy makers punished responsible savers and responsible company managers – Those who borrowed huge amounts of money to buy back their shares and speculate were rewarded. Our monetary policy has set Western economies on a path for deflation (shrinking production along shrinking balance sheets)
The West sits strategically in a tragic trap of her own making. Russia and China are taking advantage of this historic opportunity.
Stagflation – a very possible medium term scenario
There is the real possibility that the FED is too late to tame the inflationary spiral in the economy. If so, Inflation and negative growth would set in (stagflation). Would the FED be terribly surprised at this? No.
Policy makers have long known that this is a risk they are running. Both the FED and ECB are working together for years to create maximum inflation, letting it run hot (by keeping interests near zero while inflation runs at 7% .. “we will hike interests rates .. next year”. That strategy to have zero interest rates despite elevated inflation is helping our over-indebted Western governments ..
- postpone the day they have to default on their debt
- reduce the real overall burden of their massive debt – inflation benefits the debtor, but punishes the creditors
- allows the state to enlarge its size and role: the negative real rates hurt all households as a massive hidden income tax – making low and mid income families more dependent on state support
It is already working – we have inflation in asset prices and now consumer prices. Additionally Western governments are increasing their role and their share in the economy to compensate for the economic shrinking (stagnation). Millions of workers in the financial industry think they are working for the private economy. They aren’t – they are de facto part of the enlarged state economy.
Faced with stagflation Western governments are likely to increase regulation and their control over the economy. If the economy stalls, you can generate forced migration or force-regulate private households to change cars or heating systems. Everything points to a larger state North America and especially in Europe.
It is this highly vulnerable economic landscape our central banks have created that the enemies of the West could use to strike hard at us. Our Central Banks are giving Russia and China, (but also Turkey, North Korea and Iran) amazing opportunities to strike at the West or hurt the West’s interests. The list of options available to Moscow now is long.
I am warning since 2021 that FED and ECB policies have become the biggest threat to our National Security. These central banks and EU leaders have rather unknowingly advanced Russia’s interests.
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Last but not least – No part of this analysis should be taken or construed as an investment recommendation.
As you know geopolitical and financial conditions need close monitoring, because conditions can change quickly. Every analysis has to be updated regularly. Finally, every person has specific needs and restrictions that need the attention of a professional adviser.
Independent Global Geopolitical Macroeconomic Research
Christian Takushi MA UZH, Macro Economist & Geopolitical Strategist
Original release 15 Jan 2022 – Switzerland – Truncated public release 23 Jan 2022
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