Interpreting Very Scary Macro Charts

Earlier today, Fund Manager and well-known weekly market comment author John P Hussman posted the following chart on a tweet, illustrating the exponential decay of the short term interest rate as the Fed's balance sheet grew with respect to nominal GDP:


My first reaction was one of shock, particularly because the last 3 days of rates increasing have been painful enough as it is! There seems to be a very clear trend here that makes for a Very Scary Macro Chart. However, let's try to digest this calmly. The "You are here," arrow points to a place that looks to correspond to a 0.20 ratio of MB to NGDP. Loosely following the sample path leads us to believe that the area between 0.08 and 0.10 is home to the 2% 3m bill rate. Considering the below-target level of inflation and Chairman Bernanke's wording about not selling assets, we can conclude that, in the near-term, it would have to be an increase in NGDP that led to those higher 3m rates. Using the 0.1 barrier for the sake of simplicity, it would roughly mean NGDP doubling. To gauge the true scariness of Dr Hussman's chart, we could look at forward rates and find when the yield curve is pricing in a 2% 3m bill. Lucky for us, the Eurodollar curve provides a fast and easy way to find this out. Assuming a 15bp FF-LIBOR spread, a 2.15% 3-m LIBOR is being priced somewhere between June and September 2016 (EDM6, EDU6). Assuming no further changes to the Fed's balance sheet (although, as he indicated, more growth is planned and currently happening) it would take an annualized increase in NGDP of ~26% to get to a MB/NGDP ratio that justifies the current forward curve's pricing of a 2% 3m bill 3 years from now.

What's the interpretation? Well, it appears that the Very Scary Macro Chart would indicate that balance sheet expansion is way too dovish and that rates are too damn high, making eay for a flatter, lower yield curve; a high level of NGDP growth; and a shrinking Fed Balance sheet to be able to peacefully coexist. If that is the case, we would consider Mr Hussman to be much more of a bright-eyed, bushy-tailed optimist than he sometimes lets on.



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