Quote from Specterx:
It's just a supposition, but I think we'll come to a moment where the Fed must decide whether to cross the Rubicon and deliberately gun inflation expectations beyond what is currently considered normal, or be forced to let asset prices meaningfully correct. The obvious thing to say is they'll continue to inflate but there might yet be a surprise on this score. The Fed's real mandates are after all to protect the banking system and the government's solvency, to the extent a 50% market plunge doesn't directly threaten these the Fed may well judge intervention to not be worth the risk.
Wholly agree this could happen -- though to my mind that would qualify as a "Minsky Moment" in which a new worse-than-2008 crisis is upon us.
For the Fed to go "nuclear" we would likely need to see the return of economic recession, bordering on outright depression, as such that the stability of the global banking system is again threatened.
But if we get to that point with long bond yields below 3% or even 2.5% -- as bonds will surely have pushed to new heights in such a malaise scenario -- then the Fed is up shit creek without a paddle. What happens when you've cranked the defibrillator up to 10 and still no patient response?
If you imagine a scenario where the economy is deflating and the Fed is out of bullets -- other than pulling out the nuclear option -- too hard of a "deliberate inflation" push could finally be the straw that breaks the bond market's back (while sending precious metals over the moon).
A fear of total breakdown in the system could lead to treasury bonds collapsing in the midst of a Felix Zulauf "inflationary depression" mentality, as the odds of paper currency getting debased to confetti get priced in. This is the outcome where unemployment hits GD levels and gold goes to $10,000 per ounce.
We could get from here to there... I just imagine it would be a process, for ex. a multi-month or multi-quarter deterioration, not a sudden event.
All idle speculation of course...
p.s. Correction -- what I described there was a Fed with its back against the deflationary wall. You were referring to a pre-stage event to that, more of a 1937 scenario, where the Fed decides to withdraw support even as the economy stumbles.
I rather doubt this will happen, as Ben Bernanke knows the lesson of 1937 and fears deflation more than inflation. But if it does, and the underlying economy is as weak as the macro bears say it is, we would still wind up in the Minsky place I described.
p.p.s. Ironically, for the economy to successfully withstand the blow of a 50% market drop and full Fed withdrawal, the underlying state of things would have to be stronger than all the permabears believe, which in turn circles back around to the bullish argument that things aren't as bad as they appear. Just give me the charts thanks...
