According to Morgan Stanley‘s chief economist Vincent Reinhart, this represents the Fed’s #1 fear.
…the Fed’s chief fear will be that market participants will expect policy tightening to come sooner and more sharply than is consistent with sustaining the economic expansion. All the talk about tapering off, or even ending, QE has been careful to be conditional on the outlook. If our economic forecast unfolds and the remainder of the first half proves challenging, talk of tapering off will, well, taper off. Against that backdrop, we think the Fed will continue to add $85 billion of securities per month to its balance sheet over the course of 2013. Only as the expansion gets steam will the pace of QE be moderated.
Of more pressing concern for the Fed is the inconvenient fact that the unemployment rate keeps dropping. When the Fed first set the Evans threshold on the unemployment rate at 6-1/2 percent, it must not have envisioned the ongoing exit of workers from the labor market. While the words of the FOMC statement reassure that policy makers will look at a wide array of information, “…including additional measures of labormarket conditions,” it will be difficult to wean market participants away from the notion that 6-1/2 is a hard trigger for raising the policy rate. Fed officials have already tried to put white space between their policy decision and that number, and we look for them to do so increasingly.
Since the Financial Crisis erupted in 2007, the US Federal Reserve has engaged in dozens of interventions/ bailouts to try and prop up the financial system. Now, I realize that everyone knows the Fed is “printing money.” However, when you look at the list of bailouts/ money pumps it’s absolutely staggering how much money the Fed has thrown around.
Here’s a recap of some of the larger Fed moves during the Crisis:
- Cutting interest rates from 5.25-0.25% (Sept ’07-today).
- The Bear Stearns deal/ taking on $30 billion in junk mortgages (Mar ’08).
- Opening various lending windows to investment banks (Mar ’08).
- Hank Paulson spends $400 billion on Fannie/ Freddie (Sept ’08).
- The Fed takes over insurance company AIG for $85 billion (Sept ’08).
- The Fed doles out $25 billion for the automakers (Sept ’08)
- The Feds kick off the $700 billion TARP program (Oct ’08)
- The Fed buys commercial paper from non-financial firms (Oct ’08)
- The Fed offers $540 billion to backstop money market funds (Oct ’08)
- The Fed agrees to back up to $280 billion of Citigroup’s liabilities (Oct ’08).
- $40 billion more to AIG (Nov ’08)
- The Fed backstops $140 billion of Bank of America’s liabilities (Jan ’09)
- Obama’s $787 Billion Stimulus (Jan ’09)
- QE 1 buys $1.25 trillion in Treasuries and mortgage debt (March ’09)
- QE lite buys $200-300 billion of Treasuries and mortgage debt (Aug ’10)
- QE 2 buys $600 billion in Treasuries (Nov ’10)
- Operation Twist reshuffles $400 billion of the Fed’s portfolio (Oct ’11)
- QE 3 buys $40 billion of Mortgage Backed Securities monthly (Sept ‘12)
- QE 4 buys $45 billion worth of Treasuries monthly (Dec ’12)
The Fed is not the only one. Collectively, the world’s Central Banks have pumped over $10 trillion into the financial system since 2007. This money printing has resulted in a massive expansion of Central Bank balance sheets as the below chart indicates (BoE= Bank of England, Fed= US Federal Reserve, ECB= European Central Bank, SNB= Swiss National Bank, BoJ= Bank of Japan).
This money printing has unleashed inflation in the financial system. In the emerging markets, where consumers can spend as much as 50% of their income, this has resulted in food riots and even revolutions as we saw with the Arab Spring in 2011.
This situation is far from over. Higher food prices continue to be a source of civil unrest throughout the emerging market space. Recently Saudi Arabia banned the exporting of poultry to halt prices which rose by as much as 40%:
“When your debts are 24-times your government tax revenue, you have a secular decline in population, and all of the things are finally catching up to you, what happens when you have a debt crisis?”
Central Banks believe “Devaluation is ‘supposedly’ the way to freedom”
3:00 – Japan’s tearing social fabric
4:30 – G7 Kumbaya unwind
6:00 – “There is no way out” for Japan – it’s a matter of when not if. And “if there is no way out for them, there is no way out for the rest of us – unless we change the way we operate.”
6:30 – “If there is no consequence to the US profligacy [rates not moving against them] well then they will keep spending.” - “Central banks are enabling the spending”
7:15 – “The Modus Operandi of the west is running deficits; and what that has meant in the past is runaway cost-push inflation – and I think that is what we are going to see”
8:00 – “Investors are too complacent” – this is the single-most riskiest time to be complacent in our generation - “investing with the typical endowment model… is not going to work”
9:00 - “The insidious nature of a runaway inflation is that it bankrupts the middle class… the poor stay poor, the middle class (with savings in the banks) get wiped out, the wealthy (with productive assets) do the best”
9:40 – … which leads to social unrest globally – and that is a problem…
There is still an incredible amount of misunderstanding on Wall Street about the relationship between the price of gold and the true value of the U.S. dollar. Most pundits simply claim that a rising dollar, as measured by the Dollar Index (DXY), causes gold prices to fall…and that is the end of their analysis.
In truth, the dollar’s intrinsic value carries the most weight in determining the price of gold and not simply how the dollar is faring vis a vis a basket of other fiat currencies. According to many market analysts, the 5% rise of the dollar on the DXY since February has been attributed to the return of “king dollar” and that, as they claim, is why gold prices are falling….
In the US, politicians are celebrating their accomplishments that the US unemployment rate has declined to 7.6%.
Of course, the real figures show that the labor force participation rate (effectively the percentage of society that they consider to be in the work force) has just hit a 30-year low. And the economy is failing to create new jobs.
Perhaps most of all, the US debt level this year will hit the danger zone that Greece was in just a few years ago when the European debt crisis kicked off in earnest.
In Europe, the situation is so bad that even the government figures are dismal. Italy is officially in a deep recession. Spain is posting a public deficit over 10% of GDP. The Greek economy shrank (officially) nearly 6% last year. Etc.
Bottom line, the numbers don’t match up with sentiment at all. And this makes for precarious investment conditions.
Over the first quarter of this year, US stock mutual funds reported $52 billion in retail investment inflows, according to market data firm TrimTabs. This is the highest inflow in a decade.
In January of this year, retail investors poured a record $77.4 billion into the stock market. To put this in perspective, the prior record, set in February 2000, was $23.7 billion.
You can probably guess how that turned out. This whoosh of money into stocks happened mere months before the crash.
It certainly seems strange when you stack it all together: on one hand, record high deficits, record high debts, record low labor force participation. On the other hand, record high stock market, record high mutual fund inflows.
Something just doesn’t add up.
Investors are throwing caution to the wind right now… ignoring the basic fundamentals and focusing exclusively on euphoric sentiment. (Or central bank policy).
Some of you may know that I was a competitive fighter for a number of years. I can personally attest, and any boxer will tell you, that it’s the punch that you don’t see coming which knocks you out.
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