“For decades now bond vigilantes have been asleep on their sunbeds, lulled into a slumber by the soothing lapping of waves of secular stagnation and the froth of quantitative easing washing gently against the shore,” Edwards argues. 

    By the third quarter of 2022, that dynamic was “drowned out by the sound of UK gilts screaming in agony – as the UK’s tortured public sector finances have awoken Rip Van Vigilante and he ain’t happy.”

That “awakening” of the vigilantes, Edwards notes, was one of the first signals that markets risk being transported back to the mid-1990s.

    Worse, the Fed’s overtightening could further dampen private sector investment in productivity-enhancing technology.

One increasing pressure point to watch as Powell keeps ratcheting rates higher: the divergence between the benchmark Fed funds rate and interest rates on checking accounts, particularly since Powell’s team hiked rates last week by 25 basis points to the 4.75% to 5% range.

    “Higher rates as a source of instability for deposits and Treasury holdings is highly unusual compared to previous banking crises, where the source of instability has typically been credit losses putting downward pressure on the illiquid side of banks’ balance sheets,” notes economist Torsten Slok at Apollo Global Management.

    Gave notes that how Powell responds to Washington’s inflation trouble will decide where the dollar and Asian markets go in the months ahead. “So, if we look back at the last 50 years or so, how has the US dollar stacked up as a reserve of value?” he notes. “Between 1971 and 1980 – essentially Burns’s time in the Fed chair – the US dollar woefully underperformed gold over each horizon.”

    Between 1980 and the mid-2000s – the Volcker-Greenspan era – the US dollar outperformed on each count. Gave notes that since the mid-2000s, when Ben Bernanke took the Fed chair, the US dollar has shown a “deterioration in its function as a reserve of value, to the point where today it is underperforming gold over each of the three time horizons.”

    What’s more, Gave says that when US inflation is accelerating, “the US stock market always does worse than gold.” And when the relative performance of the S&P 500 against gold has fallen below its seven-year moving average, the US has tended to be on the cusp of a structural bear market, as in 1932, 1972 and 2002. In March 2023, the relative performance broke below its seven-year moving average.

    Gave concludes that “all this leads to three important conclusions. One, the US dollar is no longer a reserve of value. Two, the US is in an inflationary period. Three, a “structural bear market has started in US equities.” At this point, Gave says, “the only way to be bullish on US equities is to expect energy prices to fall over the next few quarters.”

    Not everyone agrees. Regarding Gave’s point one, economist Michael Pettis at Peking University doesn’t buy the argument that the Fed’s actions are imperiling the dollar’s global role. “It’s because of the dominance of the US dollar that foreigners must acquire massive amounts of US assets to balance weakness in their domestic demand, which means that the US must run massive deficits to accommodate these inflows,” Pettis says.

    Pettis also downplays the odds the yuan can replace the dollar anytime soon. Specifically, he pushes back on the view held by political commentators like Fareed Zakaria that “if Xi Jinping wanted to cause the greatest pain to America, he would liberalize his financial sector and make the yuan a true competitor to the US dollar.”

    Pettis argues that “Beijing won’t – not because it wants to be kind to the US but rather because doing so would force China to absorb demand weaknesses from the rest of the world rather than use the dollar to export its own demand weakness. Beijing knows this would be terrible for its economy.”

    Even so, the Powell Fed’s decision whether to keep tightening, Volcker-style, will have grave consequences for Asia’s 2023 – consequences that all too many policymakers and investors seem not to take as seriously as they should.