More than a year of monetary tightening could not help but leave its mark.
In Europe, the central bank's hawkish approach has led to a slowdown in industrial activity and lower GDP forecasts by credit rating agencies. At the same time, in the U.S., the economy itself has cracked.
First, through bank turmoil. Within five days in March 2023, three small and medium-sized American banks - Silicon Valley Bank (SVB), First Republic Bank (FRB), and Signature Bank - collapsed. The Fed's bailout program calmed the situation, but it did not address the root of the problem and will thus not resolve the issue at heart.
So it should come as no surprise that SVB's heirs continue to suffer the effects of restrictive monetary policy. Problems in the commercial real estate market do not add to the optimism of this part of the financial sector. Not surprisingly, hedge funds continue to aggressively short U.S. regional bank stocks.
So far, however, that bet has not paid off. According to S3 Partners LLC, because of the continuing bull market, traders' play against New York Community Bancorp stock has resulted in a paper loss of about $64 million this year. Thus, the idea may be right, but the timing is not; still, it's worth adding the company to the stock screener.
What to expect next?
One thing nobody talks about is that the current growth of the stock market comes at the expense of future generations. Trying to get out of the coronavirus crisis as fast as possible, the regulator got the economy hooked on the drug of QE and cheap money in the form of low-interest rates.
But, as you know, free cheese only comes in a mousetrap. The price for the bailout was more debt and inflation due to the increase in the money supply. Since the letter issue was not resolved as expected, the Fed had to act again, but in the opposite direction, which caused the cost of debt service to skyrocket.
Interest expense on the national debt from October through May was $424 billion ($311 billion a year earlier). It is now one of the most significant budget items after Social Security, Medicare, and Homeland Security, and it may become the largest item by 2030-2032. It is unclear who will pay for all of this, given the aging population.
Turning to the rest of the iceberg, according to a recent study by Fed economists Ender Perez-Oriwe and Yannick Timmer, an increasing number of troubled companies are at risk of bankruptcy because of tight monetary policy. Specifically, 37% of nonfinancial companies are struggling.
It doesn't take a genius to realize that a wave of bankruptcies could lead to a sharp slowdown in investment and employment, leading to a deep recession. A repeat of the historic 1929-style crash of the S&P 500 is unlikely, but the outlook remains fragile, so it won't hurt to have some safeguards and tools in place just in case.
When will the time bomb go off?
There is often a lag between changes in monetary policy and their effect on the economy, suggesting that the real spark will come next year. Still, markets are counting on the regulator to bail them out if things go wrong.
For instance, Michael Howell, managing director of Crossborder Capital, believes that the U.S. regulator will soon abandon QT in favor of injections, not to save the banks but the countries with a high debt burden.
As a result, instead of the projected $7.5 trillion by 2033, from nearly $5 trillion now, the Fed's Treasury assets will grow to $10 trillion, if not more. The fact that renewed QE would lead to another rise in inflation doesn't bother anyone...
The Fed may rescue it, but only when the world gets scared. In addition, the ammunition is unlikely to be used to its full potential; otherwise, it will only be possible to get out of the vicious circle in the next decade at the earliest.
