The Minutes revealed that the Fed
Cares not about outlooks, instead
Inflation be damned
They now are programmed
To wait until growth is widespread
There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh? Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time. We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around. And that’s great! Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis. Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive. And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come. A cynic might think that those central banks don’t actually believe their own forecasts.
Yesterday’s FOMC Minutes revealed this exact situation. “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.” In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates. On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves. After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”
It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations. For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano. I’ve been sitting on that volcano for many, many years. It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices. Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever. And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.
Thus, the conundrum. Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue. Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy. But every central bank has essentially promised they will be falling behind the curve to fight the current battle.
So, let’s follow this line of thought to some potential conclusions. Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse. Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation. (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!) Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money. Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter? This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B. And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below). Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.
So, with that in mind, let’s take a quick tour of the markets. Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day. In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher. As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.
As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs. European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point. A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year! Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget. Imagine what would happen if yields there rose, even 100 basis points. And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.
Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector. And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline. But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.
In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today. Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week. As described above, inflation s clearly not going to be a major policy driver in most economies for now. But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.
On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon. But what can the Fed tell us that we don’t already know?
As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well. And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.
Good luck and stay safe
If policy is premised on outcomes, not the outlook, then we don’t actually need a Fed. That’s the supposed Friedman prescription: let a computer manage monetary policy. As time goes on and we see more and more of the ridiculous and avoidable mistakes of activist central bank policy, I get more and more aligned with that view. Enlightened monetary policy management could certainly add value. But we don’t have anyone who can do it.
Well, for one thing, if there was no Fed, where would the 3000 economists who work there get jobs? after all, none have demonstrated skills with practical value.