The Japanification of the US Markets

If you blinked, you might have missed the S&P 500’s 1.1% plunge last Wednesday… …following the highest CPI print since 1990.The print was followed two days later by the lowest consumer sentiment reading in 10 years, a result driven primarily by…wait for it…inflation fears.  Stocks actually rose on the day.Until a few months ago, the market’s non-reaction might have been driven by the “bad news is good news” meme. Translation: bad economic news will prompt the Fed to pour a few more trillion into the markets.

But, the Fed recently announced that it is trimming its $120 billion in monthly stimulus by $15 billion per month, with an eye toward raising interest rates sometime in 2022. Shouldn’t that mean “it’s different this time?”

Even with the taper, the Fed still has $105 billion to play with this month — plenty enough to move markets and stoke further inflation. And, with his job on the line, Jay Powell is unlikely to allow markets to experience a long-overdue correction, no matter how justified such a reaction might be.

It’s not entirely Powell’s fault. He’s simply following in the footsteps of his predecessors, both here and abroad. Central banks’ policy mistakes have been years in the making, based on the erroneous assumption that markets can be manipulated indefinitely without consequence.

The all-time champion of market manipulation, of course, is the Bank of Japan. Japan has ¥1.2 quadrillion in debt (about $12 trillion USD), which is roughly 277% of its GDP. Its annual budget deficit is approximately 14% of GDP. It pays about 40% of every tax dollar it collects to service just the interest on its mountain of debt.

The country has managed to stay (nominally) afloat only because the Bank of Japan, the GPIF and large Japanese banks purchase nearly all of Japan’s debt issuance — artificial demand for securities which arguably don’t merit any demand at all.Last night, the Japanese Cabinet Office announced that Q3 GDP had declined at an annualized rate of 3% vs -0.7% expected. Below the surface, the data was even worse. Private consumption fell at an annualized pace of 4.5%, capital spending dropped 14.4%, and exports fell 8.3%. How did the market react?

The Nikkei 225 futures dipped less than 0.5% intraday and are back in the green as we go to press.

What do we mean by “Japanification?”

The US’ $29 trillion in debt is about 126% of GDP. The budget deficit, almost $3 trillion in 2021, is roughly 13% of GDP.  Interest on the debt is roughly 9% of taxes collected — more than the federal spending on food and nutrition services, transportation, housing, or education.

Thanks to the Fed’s intervention, however, interest rates are near all-time lows. Equities, real estate, and nearly all other asset classes are at or near all-time highs. About the only thing falling with any consistency is vol, particularly when any overhead resistance is met.

While arguably better off than Japan, the US is clearly following in Japan’s footsteps when major economic missteps result in minuscule market reactions. It might take time for the economic tax imposed by the Fed’s inflation policies on lower and middle-income Americans to show up in the data, let alone the financial markets. But, the absence of price discovery exposes the same stunning lack of market integrity seen in Japan.



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