The Fed released the minutes from the March 17-18 FOMC meeting and we would all do well to remember to be PATIENT and not be so quick to react to the headlines. (Again, I am going on record to plead that the Fed not release any data early to journalists so they may be able to release their headlines in unison with the actual Fed release. Many journalists write headlines that are misleading and allow the HFT algorithms to exploit key word phrases that are not substantiated by the actual story.) A case in point is the CNBC headline that appeared at the moment of the Fed release: “Several Participants Judged That Economic Data And Outlook Were Likely To Warrant Beginning Normalization At The June Meeting.” Yes, this is a direct quote from the minutes but it comes with a QUALIFIER. Following that line is this: “HOWEVER [emphasis mine], others anticipated that the effects of energy price declines and the dollar’s appreciation would continue to weigh on inflation in the near term, suggesting that conditions likely would not be appropriate to begin raising rates until later in the year, and a couple of participants suggested that the economic outlook likely would not call for liftoff until 2016.”
The FED Minutes repeatedly use the words, MAJORITY, MANY, A NUMBER OF PARTICIPANTS to convey the people’s interactions during the FOMC meeting. There are only TEN members who voted at the March meeting so these measures of possible combinations of votes do not demand such vague verbiage. Tell us the absolute numbers of pros and cons and let market participants draw their conclusions. The FED is creating volatility through poor communication. If you have something to definitively say, just say it. In using the aforementioned terms, the Fed conveys that there were those in opposition to the FOMC‘s decision and brings to question how the vote was unanimous. It just doesn’t add up.
The minutes did reveal a great deal of discussion about the use of the O/N RRP and IOER to drain excess reserves and even noted the idea of SELLING ASSETS from its balance sheet as a way of reducing O/N RRP usage. From the Minutes:
“Many participants mentioned that selling assets that will mature in a relatively short time could be considered at some stage, if necessary to reduce O/N RRP usage. However, a number of participants noted that it could be difficult to communicate the reason for such sales to the public, and in particular, that the announcement of such sales would risk an outsized market reaction, as the public could view the sales as a signal of a tighter overall stance of monetary than they had anticipated or as an indication that the Committee might be more willing than had been thought to sell longer-term assets.”
This is an absolute admittance that the FED IS CAPTIVE TO THE PHOBIA OF ANOTHER TAPER TANTRUM. The FED is heavily dependent on the reaction function of the market place and I would assume that the word PUBLIC is a euphemism for WALL STREET. As I wrote in response to the FOMC meeting and Yellen’s press conference, the FED CAME, SAW and FAILED TO CONQUER ITS FEAR. In the fashion of Colin Powell it seems the FED has broken the markets through massive QE and now it turns out they own the outcomes. ASSET PRICES ARE THE NEW WEAPONS OF MASS DESTRUCTION.
***Last night, the Bank of Japan decided to stay the course on interest rates and its QQE Program (quantitative and qualitative easing). The vote was 8-1 with one BOJ member pushing for an increase in monetary stimulus. The market may have been a little surprised because of a Reuters article from April 1. Titled, “Abenomics Architect Says BOJ Must Ease Again on April 30,” the substance of the news being that Kozo Yamamoto, a leading LDP expert on monetary was pushing for more stimulus by the BOJ. It seems that Mr.Yamamoto was the main push behind last October’s surprise move by the BOJ to increase QQE asset purchases.
The market didn’t react aggressively to the Reuters article but it is something that should stay on our radars. In talking with Tobias Harris, his initial response was that there is push back to Mr. Yamamoto because the weakened YEN has been a burden to the middle class as import prices have risen. (A secondary effect of a weakened yen as it impacts the average Japanese purchasing power and thus it would be too soon for the BOJ to enhance its asset purchases.) If more information appears I will analyze it.
Tomorrow, the Bank of England announces its interest decision. There will be no change because of the upcoming elections and Governor Carney is not happy with the strength of the British pound relative to the EURO. Britain’s main trading partner is Europe and with the current account deteriorating Mark Carney will not to anything to add further strength to the British Pound,thus no change.
***Pay no attention to the IMF and its warnings about a global slowdown. The IMF is a fine micro analyst but its macro views would not be of value for investors. Yesterday, in its World Economic Outlook, the IMF joined the club of “SECULAR STAGNATIONISTS” and lowered its growth forecasts for the next five years. The media relishes the IMF announcements but investors would be much poorer if they invested in response to the output of IMF research. More importantly, the IMF is a conduit of G-7 political as well as economic policy and its research is to be judged in that regard. The present IMF involvement in the Greek bailout is a classic case of politics before economics as is the current efforts in the Ukraine. Caution indeed.
***A tip of the hat to Fred Smith, the Chairman of FEDEX. It was announced yesterday that FEDEX is planning to purchase TNT EXPRESS in an effort to expand its European presence. In a Financial Times article Fred Smith is quoted as saying “… the timing of the deal with the Netherlands company was influenced by the strength of the U.S. dollar as well as signs that lower oil prices and the ECB’s monetary stimulus were delivering a boost to Europe’s economy.” It is an intelligent CEO who uses a strong dollar and low borrowing costs to acquire assets when financial opportunities arise. The DOLLAR won’t be strong forever so it is wise to use an asset that has recently appreciated 25 percent to add growth. The work of Andrew Smithers in using Tobin’s Q theory about mean reversion in finance is what Fred Smith utilized. TNT‘s assets became cheap in dollar terms so in classic Tobin theory it became cheaper to buy than to build.
Many others will follow FEDEX in an effort to increase a European and global footprint ,so analyze foreign companies that are possible acquisition targets. In Canada, POTASH corporation has been a possible type of target. In 2010, BHP Corp offered to buy the world’s largest fertilizer company for the equivalent of $40 billion and the Canadian dollar was very strong at 1.05 Canadian to the U.S. DOLLAR. Today the POTASH market cap is roughly $27 billion and the Canadian dollar has depreciated by 20 percent to 1.25. In terms of the Chinese yuan, the Canadian dollar is more than 30 percent cheaper making the world’s largest fertilizer company a tempting target to the world’s largest food consumer. Low interest and depreciated currencies can prove to be a potent mix.
Tags: BOJ, Fed, Fedex, FOMC, IMF, IOER, Janet Yellen, O/N RRP, patient, QQE, secular stagnation, taper tantrum
April 9, 2015 at 3:03 am |
as usual great piece and perspective, only comment is that NO ONE watches CNBC anymore
April 9, 2015 at 5:11 am |
“The FED is creating volatility…” Your “friend” Warren Buffett: Volatility is not the same thing as risk, and investors who think it is will cost themselves money. (Annual letter to shareholders, 2015)
April 9, 2015 at 5:22 am |
Arthur–if I had a 40 year time horizon as Buffet does I would agree –or maybe a two year horizon,but most people are traders as well as investors ,even the Dalios,Tudors,Kovners,Druckenmillers are effected by by the risk in senseless volatility–see October 15th,2014 and may 22nd 2013 for starters—oh yes and January 15th,2015–there is risk in volatility
April 9, 2015 at 6:42 am |
Yra and Group,
Still working on this. It’s a variant of what I posted on Notes last September.It makes sense to me.
I know the FED will not want to give up their power to change rates, but I think they are smart enough to look at their forecasting record, and see that they need help. They missed the 2008 downturn, which could not have been any more obvious.
Any suggestions to improve this?
I will try to get this out to some of the business media, in a few days.
Fixing Monetary Policy 4/5/2015
The FED has indicated that they will raise interest rates, at some point in 2015. This has been based on the premise that the strong employment numbers are signaling a strengthening economy.
Employment tends to be a lagging indicator, and often follows Consumption Expenditures (PCE), with a lag of about a year. PCE has been weak since the middle of last year (see chart below). Companies do not typically “fire until they see the whites of the eyes” of the recession
Many economic indicators numbers (other than employment) have been weak this year. Retail sales have been “weakish” since April 2015. Important leading world economic indicators, such as the BLS Index of Industrial Commodities, the Baltic Dry Index, and Crude Oil have been in raging bear markets for months. It is possible that the USA economy will soon enter a recession.
Since the “financial crisis”, the FED has kept interest rates exceedingly low. Though it has long been standard operating procedure to lower interest rates during a recession, the magnitude of this “easing” has been unprecedented. The apparent result has been a sharp increase in asset prices, but consumer and business spending has not rebounded at a rate typical of previous economic recoveries.
“Easy money” policies are believed to have led to the price inflation of technology stocks and the crash of the “tech bubble” in 2000. The “financial crisis” of 2008-2009 was caused, in large part, by the extreme price inflation (and collapse) of only about $2 Trillion of sub-prime mortgages.
The magnitude of the “easy money” policies of the FED (and other Central Banks), over the past 5 years, dwarfs any previous efforts to inflate the world economy. This has led to the extreme price inflation of at least, tens of $Trillions of financial assets. If economic history teaches us anything, it is “the bigger the bubble the bigger the bust”.
It is widely believed that extreme low interest rates strengthen the real economy. This is only partially true. Low interest rates are essentially a Zero Sum Game……… as every dollar saved by borrowers is lost income to lenders (investors). Conservative investors in bank savings accounts, money market funds, certificates of deposit, and Treasury securities have been hurt financially by low interest rate policies, and their purchasing power has suffered. Tell conservative retirees, who depend on interest from money market accounts and CDs, how uber low rates are helping their financial situation.
So what do we do now? How do we attempt to stabilize the economy, fix the disequilibrium that exists between borrowers and lenders, and help solve the problem of bubbles that led to crashes in 2000 and 2008?
The ability of the FED (or any economist) to forecast a weakening or overheating economy, and react appropriately, is limited. Reference the recent experiences of 2000 and 2008. Therefore, we need a market-based mechanism, which will automatically “discover” the “fair market” level of interest rates and credit, and automatically adjust to market conditions, in real-time.
The best course of action for the FED is to float the Fed Funds rate, and let the “free market” set interest rates and ration credit.
Floating Fed Funds will have the following immediate benefits—–
1) Give investors, the business community, and the country as a whole, confidence that the USA economy is not “rigged”
2) Discover the right price of credit/interest rates, based on real-time supply and demand, not by someone’s guess as to what might happen in the future
3) Allow asset prices to find a reasonable “free market” value, not subsidized by ridiculously low financing rates. This would give confidence to investors that asset prices are real, and not just a bubble. It would also help to shortstop future bubbles
4) Incentivize companies to make capital investments, without fear that the current economy is being kept afloat only by low interest rate subsidies
5) Give lenders (investors) a fair “market-based” rate of return
6) Help us avoid the “boom/bust” cycle which appears to be intensifying over the last 2 decades. A “free market” will “ration credit” by increasing interest rates when appropriate (thereby minimizing “bubbles”) and “making credit more available” by lowering interest rates when appropriate, (thereby minimizing ”busts”).
Floating the Fed Funds rate gives us, by far, the best chance to realize all these goals.
Trading in the Fed Funds market has declined drastically since the onset of the financial crisis……..there is so much liquidity in the system, that banks do not need to borrow often to meet “reserve requirements”. As economist Lawrence Berra would say, “Interest Rates have gotten so low in the Fed Funds market, no one borrows there anymore”.
In order to restore functionality the Fed Funds market, Fed would need to phase out the policy of paying interest on “excess balances” (sometimes referred to as “excess reserves”), held at the FED. If this did not eliminate these “excess balances”, the FED would need to drain these balances, by conducting “matched sales” (the sale of Treasury securities to banks in exchange for the “excess balances”). If the FED believes that “excess balances” at the FED are needed to safeguard the banking system, they can simply raise “reserve requirements” (balances required by banks to be held with the FED).
Eliminating “excess balances” held at the FED should help revitalize the Fed Funds market. Banks would then need to borrow on a somewhat regular basis to meet “reserve requirements”, as there would be no “excess balances” at the FED, which could be used to meet “reserve requirement”. The FED would still be able to inject/remove liquidity to deal with capital imbalances in the banking system, and to deal with crises.
The best solution to strengthen the economy and prevent future economic disasters is to let “free markets” ration the cost of credit. When supplied with ridiculously “cheap credit”, asset price inflation will typically proceed to excess. Exaggerated downturns caused by bubbles are dangerous. The “financial crisis” of 2008-09 was far from a worst case scenario. The world economy barely held together, and we may not be so lucky the next time.
Economists en masse, have a poor record of forecasting downturns and upturns in the economy. A “free market” in Fed Funds will automatically act as a governor to prevent the economy from overheating (by raising rates and making credit more expensive, when appropriate) and an accelerator to bolster to the economy (by lowering rates and making credit less expensive, when appropriate), thereby fostering a more healthy economy.
A “free market” in Fed Funds has the best shot to be the accurate “one-armed economist” that we have all been searching for.
April 9, 2015 at 5:35 pm |
In the case of Potash Corp. I think it is worth mentioning the Provincial Government of Saskatchewan (Where Potash Corp. is based) prevented the BHP take-over from happening. Not sure why it would change that policy now.
April 10, 2015 at 12:12 pm |
FEDEX probably doesn’t view Uber as a competitor? More on the micro-econ front, what’s really going on there, bottoming or sailing off a cliff?:
“Asia-North Europe container freight rates fall 8.8%
By: Reuters | Apr 10 2015 at 03:54 AM | Liner Shipping
Shipping freight rates for transporting containers from ports in Asia to Northern Europe fell by 8.8 percent to $466 per 20-foot container (TEU) in the week ended on Friday, a source with access to data from the Shanghai Containerized Freight Index told Reuters.
It was the tenth consecutive week of falling freight rates on the world’s busiest route and it is the lowest level since the index has been compiled since the end of 2009, the source said.
In the week to Friday, container freight rates fell 8.4 percent from Asia to ports in the Mediterranean, rose 18.2 percent to ports on the U.S. West Coast and rose 0.6 percent to ports on the U.S. East Coast.”
April 15, 2015 at 8:41 am |
excellent piece YRA, thanks