In a QE financial bubble that was a response to a popping housing bubble, monetary policy and expectations of future policy are a large driver of the markets. But in the end all bubbles end the same way.
Federal Reserve Chair Janet Yellen gave a speech in New York yesterday and spelled out what she is now using to determine when to raise rates. For years it has been unemployment (initially targeting 6%) and the Fed’s completely arbitrary 2% inflation target. Now that those targets have been met and exceeded she is piling on more requirements before she stops punishing savers and pension plans. The new list includes:
- Foreign economies and their financial markets need to stabilize.
- The dollar can’t appreciate further. That would depress inflation and exports, and hurt U.S. manufacturing.
- Commodity prices need to stabilize to help foreign producers find a better footing for growth.
- The housing sector needs to make a larger contribution to U.S. output.
- Inflation is a two-sided risk: Yellen is skeptical that the recent rise in core inflation, which strips out food and energy, “will prove durable.” She is watching closely.
I’m surprised she left world peace off the list. I do not disagree that these are problems, but I also do not think Fed’s current policy will any impact on solving any of these problems and is creating additional structural issues. Then consider the Fed admitted there is *no* evidence QE boosted the economy. So why do they continue these policies? Because there is nothing else they can do but to continue to pander to the financial markets.
Of course the financial markets love this since her requirements may not be achievable ensuring below-inflation interest rates forever. But before getting too excited about it, remember low interest rates and QE have not improved the economy significantly and may be actually slowing economic growth as people realize they need to save more and spend less to survive retirement.
Some in the Fed are waking up to the fact that low interest rates may actually be causing low inflation (and I would add slower economic growth). Also consider loose monetary policy also did not stop the last two bear markets.
The flip side of the speech was her admission that all is not well in the US or global economy. The question is once the initial euphoria dissipates, will the markets focus more intently on the lack of economic growth? Possibility. On the other hand, the financial markets now have broader bad-news-is-good news to bolster their confidence in prolific monetary stimulus since Yellen gave them the entire world’s economy for bad news.
Some on Wall Street are giddy about how Yellen just publicly linked monetary policy to the financial markets. Financial markets go down, expect more QE. But I think this line of thinking is limiting going forward due to the decline in corporate earnings and global trade. Especially since policy never worked the first time.
The global economy is in trouble, but years of massive over-investment in production does not just go away with additional easing. Significant amounts of debt are non-performing in China and the commodity economies. Stabilizing the dollar will stop increasing pressure on the global dollar credit markets but it will not relieve them. Let’s think about our monetary policy some more…
Monetary policy has been in emergency mode since the last crisis (which was also created by loose monetary policy). The Fed held interest rates at zero for eight years and added over $4,000,000,000,000 to their balance sheet. We have had the slowest economic recovery in 60 years.
What we did get was a nice QE bubble in the financial markets. The conditions they are now worried about are actually the financial bubble trying to unwind and its economic distortions revealing themselves. So now Yellen’s policy is really about sustaining the financial bubble.
We have learned recently from released FOMC notes that QE2 and QE3 were more about the European Crisis than economic concerns. When the markets were approaching the abyss this February, I recommended not carrying high exposure to equities. But we also knew we were not the only ones aware of the cliff’s edge. Not surprisingly, the markets got another concerted central bank response and the markets pulled back from the cliff’s edge and continued to rally as more financially friendly efforts were transmitted (ahead of public disclosures I’m sure).
Today, the financial markets are getting further disconnected from fundamentals as they move higher. They have been disconnected for some time, but now they are moving rapidly in opposite directions. To be sustainable something has to produce significant *economic* growth going forward. Monetary policy has not yet and we are very late in the global business cycle. GAAP corporate profits are lower today than in late 2011. Even the financially engineered SP500 earnings per share are on track for the *fourth* consecutive decline in the first quarter of 2016 and five quarterly declines in revenue.
The QE bubble is hard to predict since it is driven so much by monetary policy and expectations of monetary policy. If one used fundamental analysis, you would have left the market in early 2012. Market internals did improve in mid-February as I discussed on my website’s market commentary but the rapidly deteriorating economic and earnings kept me defensive. Those same negative factors have led to a significant response by the central banks. But once again the monetary medicine only relieves the symptoms and does not cure the patient (the economy).
Where does that leave us
The US economy is growing marginally at best with increasing global headwinds and it can not support the current valuations of the stock market. The primary driver of the stock market today is faith in the central banks’ ability to sustain the financial bubble by continuing to pull from the future. I have little faith since the future has arrived.
We must also remember the financial news is mostly written for the financial markets about what is good for them, not necessarily what is good for main street. I recommend watching Mr. Fischer’s explanation of the real purpose of QE since he was on the committee that voted for it.
Some of the best insights come from former central bank officials. I consider this a must see video starting at 2:30 and ending with his last word on supporting the financial markets going forward.
The future is here
Sustaining the financial bubble requires pulling ever more future wealth to the present financial system. Much of that future wealth is coming from main street such as the Fed’s low-interest-rate policies cost savers $758 billion, study says (25 March 2016 the LA Times).
Yellen’s answer to the loss of savings was simply that Americans would just have to work longer. In England there is Workers should double their pension savings, says Labour’s review (2 March 2016 BBC News) but of course remember there is Draghi’s Pension Poison in Europe (21 March 2016 Bloomberg Gadfly).
Extending quantitative easing to include non-bank corporate bonds is poised to make life even tougher for company pension plans. Record-low interest rates had already depressed bond yields, making it harder for companies to finance retirement promises made to employees.
It is the same everywhere and if you think you’ll have life or long-term care insurance consider that Lloyd’s of London Takes `Massive Hit’ From Low Returns (23 March 2016 Bloomberg) as do all insurance companies with less-than-inflation low risk returns thanks to our ever vigilant central banksters.
Stay buckled in, the roller coaster ride is not over.
Members, please see my latest market commentary on my views of the market going forward.