In the next recession, muni bonds will be hit and local governments will default. The Fed will use Section 13(3) of the Federal Reserve Act to buy municipal paper. And if they need even more authority, Congress will grant it.
The potential for a state and municipal fiscal and public pension crisis is a defining issue for the next downturn. Underfunding guarantees problems. The question is whether the next downturn crystallizes a crisis.
Albert Edwards says the Fed will tighten more aggressively. The increase in interest rates will be a stimulant at first. But eventually, the higher rates will catch up with debtors.
This month, we have seen an unprecedented increase in volatility. When the fundamentals take a knock, that’s when we should worry though. Let’s wait for the CPI next week and revisit this conversation.
Yesterday’s market meltdown - and today's reaction - reduces the risk that the Fed will over-tighten, taking froth out of an over-extended market.
When defaults begin to rise and the economy begins to slow, we will find out whether deficits really drive rates higher or cause inflation to rise and remain high.