E Trump-Yellen Gunfight At The Not So O.K. Corral

In the real gunfight at the O.K. Corral, which took place in Tombstone, Arizona in 1881, a long time feud between the Earp brothers and a group called the cowboys came to and end. The Earps were the sheriffs and the cowboys had threatened them over illegal activities they were engaged in. The Earps, though some were wounded, survived and the cowboys were routed. 

We hope that the new gunfight is more civil, with weapons being used confined to words and economic ideas. The end remains to be seen. The gunfight has not yet occurred. I believe it will. 

The first shot that will be fired is Yellen’s fast draw on interest rates. They will likely be raised in December. Getting ahead of inflation is important if Trump attempts to gain a massive stimulus package. The issues that lead to this gunfight boil down to full employment and clearinghouse systemic risk. While it can be argued that there are a lot of people out of work, who have dropped out of the unemployment rolls, the Fed views the American economy as fully employed. 

Full employment coupled with a large stimulus and Federal spending could result in an acceleration of wage appreciation. The Fed does not want that, preferring to wait until a recession hits to seek help on the fiscal front. Trump wants movement now. 

One might wonder why Yellen is so quick to act to get out in front of inflation. I believe Blackrock when they say bond demand is massive, and that a lot of those bonds are being used for collateral and being reserved as collateral in the event that the derivative clearing houses (CCP’s) weaken. These clearing houses net derivatives trades,  and that reduces risk. But that netting creates risk for the houses. In order to net properly, collateral is required, mostly long bonds of course:

A clearing house reduces the settlement risks by netting offsetting transactions between multiple counterparties, by requiring collateral deposits (also called “margin deposits”), by providing independent valuation of trades and collateral, by monitoring the credit worthiness of the clearing firms, and in many cases, by providing a guarantee fund that can be used to cover losses that exceed a defaulting clearing firm’s collateral on deposit. Also, it acts as a clearing firm.