Economic Hypochondria
It’s time to get the markets back to relying on forward guidance from companies on earnings, and not the Federal Reserve’s forward guidance on its extraordinary policies in place for five years now.
It’s time to get the markets focused back on companies preannouncing upcoming earnings events, and not the Fed preannouncing its reduction in money printing to buy bonds.
We need to leave the alternative universe the markets have been in for five years, where traders orbit around the fixed planet of the U.S. central bank and whatever comma or period or semi-colon is not in place in any of its “guidance” on its policy changes on money printing, when it’s buying just $85 billion worth of bonds a month when the global bond market is around $39 trillion, about three-and-a-half times what it was 19 years ago.
We need to put the genie of Fed support back into the bottle and talk instead about what is constricting the powerful bandwidth of the U.S. economy. Because let’s face it, it’s about creating wealth and not printing dollars, as one analyst said years ago.
We need to stop the central bank behaving like the U.S. government itself, in a near permanent state of emergency. This is economic hypochondria. This is overreacting to the mood swings of the markets. It’s exhausting. It’s not the real world. The government should not ever be bigger than the business cycle. But that is how we have been inured to think.
It’s about profits and interest rates. The problem is, the Fed can lose control of the long end of the bond market, as traders take the reins, but so what. Markets have adjusted throughout the decades. The Fed still has a lot of power, of course, because it sets the fed funds rate and discount rates. How companies and Wall Street recalibrate to Fed actions here is of course always key. But again, your 401K is about corporate profits.
“The stock market behaves like a voting machine, but in the long term it acts like a weighing machine,” said Benjamin Graham, economist.
Yes, inflation could get out of hand, but even Fed dove and prospective Fed chair nominee Janet Yellen has given dozens of speeches for the last five years vowing to protect the central bank’s credibility as an inflation fighter, given its long history of inflation battles dating back to the late sixties and through the seventies.
Read Yellen’s speeches, and the central banker clearly indicates she will not tolerate inflation getting out of hand, even rising above 3% annualized. Yes the Fed’s money printing is distorting the markets, but the Fed has not gotten hit yet in the head with its own boomerang.
As for what the Fed will do, the central bank has said it will keep its federal funds rate close to zero until U.S. unemployment falls to 6.5% (it's now at 7.3%), and so long as projected inflation doesn’t rise above 2.5%. Fed funds futures show a two-thirds probability that rates will stay between zero and 0.25% 12 months from now.
It will likely reduce bond purchases by $10 billion a month, and possibly cut back buying Treasuries but not mortgage-backed securities.
And even when the Fed does tighten on rates, here’s a preview of how it will do that. First, it will give a signal to the markets it will start hiking the fed funds rate in its arcane statements. Then it could likely go through a rate tightening cycle as it did after the end of the early 2000s recession.
Beginning in June 2004, the central bank put in place 17 well-telegraphed rate increases which pushed the funds rate up in quarter-point increments to 5.25%. The bond market didn’t go berserk back then. And it won’t now. Just temporarily.