First, as I have been critical of Chair Yellen’s communication efforts prior to this weeks Congressional testimony, I will give the Chairwoman an A+ for her effort this week. She was very forthcoming in her Senate appearance on Tuesday, and, more importantly, she fended off the idiots in the House of Representatives with clarity and the patience of a saint. The problem with the House is too many ex-prosecuting attorney’s who all try to get Yellen in a gotcha moment, but the Fed Chief was not falling for the trap of providing sound bites for the elections back in the home district. The Senate questions were of a substantial nature while the House was fluff of either adulation or criticism.
In a very telling fashion, CNBC cut away from the House testimony to air the wisdom of Stanley Druckenmiller from their ALPHA Conference. (For the record, it’s better to listen to Congressional hearings on C-Span for there is no time delay.) Chair Yellen’s prepared report to both chambers was very vanilla but on the issue of financial stability she made an interesting comment: “While prices of real estate, equities and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance.” In my opinion, this is a very important issue from a couple of reasons:
- What do historic norms mean when you are in an interest environment of global zero rates? More importantly, the historic norms that Bernanke and Yellen have both adhered to have been P/E ratios of the entire market indices. So the historic norms have been corrupted by the issue that Yellen raises about the leveraged loan market and lower-rated corporate debt. If corporations are increasing borrowing to buy stock and pay dividends the P/E ratios are being supported by borrowing, which will come back to haunt when rates rise and or profits slow down. In terms of HISTORIC NORMS, CORPORATE PROFITS AS A PERCENTAGE OF GDP ARE AT ALL-TIME HIGHS. How long can that be sustained so the increased borrowings for financial engineering and not CAPEX will be a burden;
- Let me say again. Chair Yellen is no Greenspan or Bernanke and will not march to the beat of a rising equity market forever. Wages are a much greater concern for Janet Yellen than financial sector profits. Until wages rise and afford the American worker a greater piece of the economic pie the FED will be active. However, the RISE OF WAGES have to come off the corporate bottom line even as interest rates remain at historic lows. If the Fed’s policies result in higher inflation so be it. The American worker needs to see some gain in their paycheck and it will be out of the corporate bottom line one way or another. If wages don’t rise but inflation increases the end result is that the worker suffers and demand weakens crimping corporate profits. As Duckenmiller widely proclaims, the FED has overstayed its zero interest policy but for Yellen it may be for good reason: increased wages through improved economic activity.
***The Stanley Druckenmiller interview with Joe Kernen was worth a watch. In quick summary, Druckenmiller maintains that the Fed has made a mistake by continuing its bond buying program and leaving interest rates at zero. He notes that the initial FED efforts of QE1 and its others like the Temporary Liquidity Guarantee Program (TLGP) staved off a financial meltdown and were brilliant. Yet the FED has maintained the program long past its expiration date and risks creating massive imbalances in the financial system. For Druckenmiller, the FED‘s problem is that it doesn’t know when it’s wrong and how to exit from its plan. Druckenmiller ultimately raises the issue of Fed CREDIBILITY. What Kernen failed to ask Druckenmiller was these two questions, which Notes From Underground continuously asks:
- If the FED is so wrong why does the long end of the yield curve keep rallying, which results in lower yields?
- Stan, if the FED is so wrong, how much GOLD are you buying, or the lack of central bank credibility should prompt large movements into the ultimate store of value. The GOLD should have fallen much more yesterday as the SPOOS and other equity markets rallied. The 30-year bond continued its rally and the curves continued to flatten, but the GOLD held. Yes, today the GOLD has rallied on geopolitical events but it needs watching to see how the metal performs after the geopolitical events become clearer. The 2/10 curve has certainly flattened recently but at today’s low of 199.5 basis points the curve is far from flat, though the short-term trend is certainly flattening. Maybe we will hear more from Mr. Druckenmiller about these trading issues.