There's Too Much Attention on the Fed
There is too much focus -- most of it misdirected -- on what the Federal Reserve may or may not do today. There are a number of reasons for this. First, the Fed is but one of several major central banks and not even the largest one based on current assets. According to Yardeni Research, the People's Bank of China has $5.2 trillion in assets, the European Central Bank has $5.1 trillion, the Bank of Japan has $4.7 trillion, and the Fed comes in fourth with $4.5 trillion.
It’s the height of American arrogance to place so much attention on the Fed. The markets may have been local in the good old days, but they aren’t now. We are in a global marketplace -- one not even remotely controlled by the Fed. Not coming to grips with that new reality may catapult your positions smack dab into the proverbial wall.
Second, the Fed keeps talking about “normal” when there is none. “Normal” requires a decent history to be defined as such, and one doesn’t exist. Since the 2008-2009 financial crisis, the markets have been anything but “normal.” You cannot return to something that no longer exists, and the massive amount of central bank intervention has radically altered the world’s finances and financial markets. I call it “Wonderland,” and Alice is your new tour guide.
The world’s central banks have created a sum of money that equates to, and will soon exceed, the economies of either the U.S. or China. Yardeni estimates the total assets of the major central banks at $19.3 trillion, an amount that is growing at $300 billion a month or $3.6 trillion over the next 12 months.
Please show me any time, any time at all, in history where this was “normal.” In effect, a new country, with no known name, has been created, and this has fueled three separate engines. The first is higher equity prices, the second is lower sovereign yields, and the third is the massive compression of risk asset yields to sovereign debt yields.
So what if the Fed says today it will start cutting its holdings next month? Unless it is a number outside of anyone’s calculation, it will be minuscule compared with the money being created by other central banks. It will certainly be hoopla in the media, but it will actually be of very little significance.
Then there is all the talk of the Fed raising interest rates again before the year is out. Moody’s Analytics reports that Hurricanes Harvey and Irma will cost the federal government $150 billion, with Hurricane Maria on the way. This number does not even take into account what it will cost states and local municipalities. Increased borrowing may be the consequence of the devastation, and it would be an incredibly poor choice to raise rates at this moment.
It will be quite interesting if the Fed acknowledges the hurricanes and the financial damage they have caused along with the physical damage in its statement today. The appearance of the words “Harvey” or “Irma” may be major bond buy signals. Technically, we are not close to either support/resistance lines for the 10-year Treasury note, which in my calculations are at yields of 2.16 percent and 2.32 percent. Bond prices could surprise everybody today and head higher.
In any event, we are solidly in an environment of higher equity prices, lower sovereign yields, and continuing compression of risk asset spreads to sovereigns. If and when the other major central banks begin to put away their printing presses, then I will reassess my viewpoint -- but not until then. Globally, the actions taken by the Fed today are likely to mean very little. All of the magically minted money must be put to work somewhere regardless of what the Fed does today.
You will hear incessant commentary about “dot plots” and the ink that has been used to connect them, inflation, or the absence of it, wages and their lack of growth, and maybe even Janet Yellen's breakfast with Ivanka Trump. Each and every financial data point is likely to be bandied about in a search for what the Fed has done and may do. It isn’t just noise, but actual misdirection if you get mentally dragged into these conversations.
As it’s said in the film “All the President’s Men”: “No, I have to do this my way. You tell me what you know, and I’ll confirm. I’ll keep you in the right direction if I can, but that’s all. Just ... follow the money.”
I also point out that what the Fed does today may be a one-off event. At some point, President Donald Trump will appoint five new members of the Fed. The days of the university economists controlling the Fed may soon be over. I look for much more pragmatic members to be enshrined at the central bank. What the Fed does today may even get reversed after the new appointments are made. You may wish to take this into your considerations.
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