In reply to El-Arian and "markets too obsessed with interest rates:...
The issue is not so much "the markets" being obsessed with interest rates... but the Fed using them as a tool trying to distract the markets from credit risks... and liquidity risks... as per prior post.
But, El-Arian also addresses "policy mistakes"... also does that while also remaining focused on interest rates... and considers that as in his prior posts saying "the Fed has lost credibility on inflation versus interest rates"...
But, he addresses only those two options on "policy mistake"... as errors in rate setting that have already occurred, and as errors in rate setting that might yet be made... making "an even bigger policy mistake"... only in context of RATES...
He addresses risks of "contagion" as it were... IF awareness spreads from "policy mistake" awareness as about rate issues in context of awareness of "what are still very loose financial conditions"... to also being SEEN as being about liquidity risks... credit risks... and not just "rate" risks ? He's clear enough about it when presenting it as about watching for that as "spillover" potential... first to credit risk... in spite of very loose financial conditions... then, if rates stay where they are... then you have liquidity risk as well... ?
BUT... he says that and addresses it as a likely set in sequences... only AFTER already saying... there is already ample evidence of liquidity risks being realized. ?
That's what he presented first as a "factoid"... that prior to the Fed speaking on Friday, rates had traveled up and down, up and down, moving over 30 basis points on no news. And THAT, he tells us... is LIQUIDITY...
Yet... never does the conversation wander from rates... to QE and QT transitions... ?
The "policy mistake" risk nthey are all obsessing over... is NOT ABOUT RATES... but about QE...
And, that mistake was made in 2012... and at every step subsequent... when QE was used AS IF it was a viable long term substitute for monetary policy easing... when it is not. That policy mistake... consists of using QE not as "a filler of black holes on bank balance sheets" applied in a FIFO arrangement... that requires banks to work at digging out of that hole... until normalcy on balance sheets is attained ? But, instead, using QE to substitute for and extend OTHER capital... which really only provides an amplification in leverage applied in those market functions where its utility is focused. And, then... as a deflationary environment pertained... assuming the impact in result in further slowing velocity... made it SAFE to do more... as it was "easing without the risk of inflation"...
But, of course... that only works where there IS a deflationary environment... and when there is NOT... what you have done is ONLY amplify the "risk free" leverage applied... in a way that ensures accelerations in the conversion of that leverage... into application AS A DRIVER of inflation when the flows are reversed under inflation... along with proofs that it was not "risk free"...
So, consider that as... the Fed and the banks "borrowing" as QE and using the QE in taking out 10X leveraged bets on futures contracts betting that there would be no inflation...
But, now we have inflation... and the tools used to leverage their way out of the balance sheet black holes imposed in 2008... have been amplified far beyond that requirement in use in the assumption they were risk free... and, in result,. they have used that tool created for digging out of the prior black hole... to create a new black hole... lacking only the recognition events tied to awareness of the fact...
The Fed could have reversed QE flows long BEFORE there was inflation... and instead was very deliberate in waiting until inflation, and awareness of inflation, had already exceeded threshold values by wide margins ? So, that's leaving only... "yeah, they knew when they did that... and intended to do that... because they want to blow the whole thing up"... or "wow, they really had no idea at all what they were doing" ? In either case... awareness and intent... not changing the outcome.
But, what it means NOW... is probably that what El-Arian is telling you... if you listen... and note the disconnects occurring between how own "rates" focus and what he says about that being error... and a properly placed "credit risk/liquidity" focus...?
Is that we've moved from "the Fed backed into a corner on rates"... and still working to engineer a viable exit, when there is none... to the Fed having already gone over the edge on liquidity...having its Wile E. Coyote moment, now, where it is hanging in thin air defying gravity... briefly... and now are doing all they can to distract us from that as a reality... for a long as possible... while hoping to still come up with some new Road Runner like ability to avoid or defy the rules less temporarily ?
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