Notes From Underground: Overheated to Overrated

In his first Congressional testimony as Fed Chairman Jerome Powell didn’t surprise as he was measured and succinct in presenting a more market-based approach to monetary policy. The equity, currency, precious metals and debt markets were all in sell mode as the prepared statement gave rise to a renewed sense that the FED will lean toward FOUR rate hikes in 2018. The key paragraph was:

“In gauging the appropriate path for monetary policy over the next few years, the FOMC will continue to strike a balance between avoiding an OVERHEATED [emphasis mine] economy and bringing PCE price inflation to 2 percent on a sustained basis. While many factors shape the economic outlook, some of the headwinds the U.S. economy faced in previous years have turned into tailwinds: In particular, fiscal policy has become more stimulative and foreign demand for U.S. exports is on a firmer trajectory. Despite the recent volatility, financial conditions remain accommodative.”

Overheated was what set the markets a flutter, but the metamorphosis of headwinds into tailwinds is a significant change and raises the idea that the FOMC will be vigilant in its awareness of non-transitory inflation. The 5/30 curve flattened dramatically closing back below the 50-day moving average at 51 basis points. As the market is uncertain about the role of long rates in a world where central banks are still active participants in purchasing assets around the globe. The market sentiment is that the FED has much more influence on the short-end of the curve, which is correct. It seems it is easier to deal with market forces rather than having to combat the machinations of Kuroda, Draghi and the People’s Bank of China. Today’s Powell testimony revealed a chairman who is comfortable thinking on his feet in a politically hostile environment.

The Democrats were on the attack, challenging Powell to change things in the employment realm that the FED has very limited ability to affect. Chair Powell empathized with members of the Black Caucus as they set the stage for the November elections with the constant barrage of concern about the tremendous increase in wage differentials between the top percent and the rest of the country, especially people of color. There is no question that black unemployment has been a serious issue but the FED has no ability to target the employment of any particular group. Wage differentials are not in the Fed’s bailiwick, belonging more to the board rooms of corporate America. It is a great concern of mine that income disparity in corporate has grown to obscene levels as the board participation by Calpers and Calstrs along with other union pension representatives has increased dramatically. The problem lies with corporate management, boards of directors and shareholders, not the Fed.

But the Democrats revealed that the Black Caucus will lead the charge in attacking the Trump administration for its budget and fiscal plans increasing the wealth divide. This was one of the most politicized hearings in many years with language so incendiary it was fit for a 1960s demonstration. Financial Services Committee Chair Jed Hensarling kept hammering Chair Powell on the issue of Interest On Excess Reserves (IOER). Look for this to be an issue for Congress as Hensarling seems intent on challenging the FED over its interest payment to large financial institutions. IOER was put in place at the beginning of the financial crisis as a tool to aid the Fed in its control over the huge amount of liquidity created to stem the mass liquidation of assets.

My one criticism of Chair Powell was when he noted that the 2% inflation target was a global standard and difficult to get away from. This is troubling because so many quality analysts have raised concerns over the artificial target of the 2%. ECB President Mario Draghi hangs his policy on this inflation target as if were ordained from Mount Sinai. The 2% target is a subjective construct that emanated out of the work of the RBNZ Governor, Don Brash. The FED‘s continued adherence to the sanctity of the inflation target may prove to be a problem, especially if wages continue to lag price increases.

***Later in the day the Brookings Institution hosted a chat with former Fed Chairs Ben Bernanke and Janet Yellen. I listened to the entire love fest as the two praised each other for a job well done. There were 10 questions from the audience that failed to shed any light on possible perceived policy errors. It was interesting that Bernanke praised Yellen for being aware of a coming housing crisis when she President of the San Francisco Fed. Yellen noted that she was a regular visitor of Anthony Mozillo when he ran Countrywide but one of the kingpins of the housing crash switched regulators in an effort to avoid the critical eye of Janet Yellen and the SFFRB.

While it is interesting that Yellen perceived the coming crisis, which won Bernanke’s praise, I would’ve asked if she was so astute why didn’t Chair Bernanke accept her wisdom instead of maintaining into 2007 that the housing downturn was CONTAINED. The saccharine nature of the Q&A left me perturbed that Bernanke moved the conference to the afternoon so as not to conflict with Powell. The Bernanke/Yellen confab was so milquetoast that CNBC did not even cut away from its usual programming even though they were prepared to report any points of interest. Chair Powell looked better every minute.

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14 Responses to “Notes From Underground: Overheated to Overrated”

  1. kevinwaspi Says:

    No disagreement at all with “Powell looked better every minute”. When compared to the Bernanke, and San Fran Jan, even a muskrat in rut looks better.

  2. Chicken Says:

    I’ve been wondering when the discussion of continued IOER would occur. Given the FED is tightening, one would expect this $30B gift of future Gods should also be diminished.

  3. Peter M Todebush Says:

    Greenspan: US ‘Underestimating Impact’ of Trump Corporate Tax Cut

    Tuesday, February 27, 2018 03:34 PM

    By: F McGuire

    Former Federal Reserve Chairman Alan Greenspan says that President Donald Trump’s landmark corporate tax cut is driving the stock market and a host of economic benefits, and that “we’re underestimating the impact of that.”

    Greenspan notes that when the tax rate is moved several percentage points, “a whole cascade of projects will fall on a ‘let’s-do-it’ type relationship, and I think that’s what’s happening at the moment.”

    “Remember that the stock market is being driven to a large extent by the one thing that I think the Trump administration did right: got the 35 percent marginal corporate tax rate and brought it down to 21 percent,” Greenspan said during a recent discussion at the American Enterprise Institute titled, “The Bubble Economy – Is This Time Different?”

    “I think that what is happening here in the United States is we’re underestimating the impact of that,” Greenspan said.

    However, Greenspan expressed hesitation and worry about the financial markets. aside from the Trump tax cut.

    “I’d argue that there’s both a stock bubble and an interest rate bubble — bond market bubble, I should say, at the time – and the bond market bubble is essentially the determining force because to reach equilibrium, it’s got to move, whereas all other aspects have a lot of fluctuation,” said Greenspan, who served as Chairman of the Federal Reserve of the United States from 1987 to 2006.

    “It is at its low— real interest rates are at their lowest levels of extremity and, by the definition, if you’re at your lowest levels, there’s only one direction you can go,” the economist said.

    “But if that goes up, then it tends to alter the earnings-price ratio and would bring stock prices down, and that’s what’s happening,” he added. “I’m not going to go out there and be a stock market forecaster. But I know what the forces are, and it’s a question here of trying to determine which is the driving force,” he said.

    Greenspan was asked how much trust the American people should place in U.S. financial institutions and the dollar.

    “Depends on human nature. Obviously, trust is a critical aspect of finance. You couldn’t have any complex society where there’s – people are willing to trust somebody over a protracted period. I mean, we sell 30-year Treasury bonds. People are willing to hold it,” said Greenspan, who currently works as a private adviser and provides consulting for firms through his company, Greenspan Associates LLC.

    “Well, why? Because they believe that even though they’re getting back fiat currency, they will get their currency back and so that you take trust out of a financial system and it collapses because it’s all based on interpersonal reactions,” he said.

    Other economic experts have touted the benefit of the sweeping tax cut.

    Investment guru Steve Forbes recently told Newsmax TV that Trump’s tax cuts will trigger economic growth of at least 3 percent to 3.5 percent.

    For a decade, economic growth has usually been below 2 percent, Forbes said. “We’ve had a few quarters that would go above it or it’d gone 25 miles an hour in a 70 mile hour zone speed zone. Now we’re going to get it up to 40, 45. Good start. And if the administration continues, Trump continues on deregulation and alike, good,” the chairman and editor-in-chief of Forbes Media told “The Income Generation Show.”

    Forbes told host David Scranton he thinks the Trump tax cuts will solidify “a 3, 3 and a half percent growth economy.”

    For his part, Trump has taken to Twitter to tout the economy, saying mainstream media outlets only distort the facts and report “fake news.”

    “The U.S. economy is looking very good, in my opinion, even better than anticipated. Companies are pouring back into our country, reversing the long term trend of leaving. The unemployment numbers are looking great, and Regulations & Taxes have been massively Cut! JOBS, JOBS, JOBS”

    — Donald J. Trump (@realDonaldTrump) February 20, 2018

    (Newsmax wire services contributed to this report).

    • yra harris Says:

      Peter—It is amazing how much clearer greenspan is now that he has no official role.He said this back in January when you warned Congress not to increase the debt and actually cut spending to offset the corporate tax cut.He is back on his game and it has been a long,long time.But on the trump piece Steve Forbes an investment guru—sorry he might as well as been at Brookings yesterday

  4. Stefan Jovanovich Says:

    As the most Rasmussen poll demonstrated, the white, brown and black geezers in the country are, with surprisingly few “minority” exceptions, all in for the Donald. They support the President because they feel that he understands their position: Medicare and Social Security payments are not “entitlements”. The current recipients of those programs made their deal with the Treasury and the Congress when they paid their employment taxes and dutifully worked our 40 quarters; they now believe fervently that it is up to Congress make good on its end of the bargain.

    The old folks don’t mind (very much) listening to Greenspan, Ryan and others preach the usual financial theology; those opinions will always dominate the headlines but – thank God and the President –
    fiscal virtue signalling no longer matters for the nation’s political economy. The President and Mr. Mulvaney have assured the old folks that no one is going to touch their payouts; and the old folks know that the President is too good a politician to believe that he and his newly-found party can avoid being Rostenkowskied if he lets the believers in the holy spreadsheet actually try to cut Federal retirment “benefits”.

    The old folks have done the numbers. They know that more than half of the current fiscal year’s deficit will spent on medical care for those people not covered by the Social Security Act. Take those away and the Federal government’s budget problems are easily solved. After all, local government knows best and that the Federal government should not be doing the States’ job. Since the vast majority of the geezers have already retired in the States that want to “reform” indigent care, they are untroubled by the prospect of having their state and local taxes go up. If the Republican Congress had to extend CHIP as the price for an Eisenhower defense budget, that is OK – for now. But, next year, after the Democrats don’t get the geezer vote, the old folks will want California to pay for its poor people, without any Federal help.

    The net advice: Buy 1 Year Treasuries, Sell State and Local Bonds, Avoid Equities and Commodities as Tariffs and Promised Rate Hikes Have the Dollar’s FX price swallow all potential gains from “Inflation”

    Historical Footnote: As a country we have been here before.

    • yra harris Says:

      Stefan–the use of Rostenkowzkied is killing me–I live five miles from that gas station where that took place.It is interesting where your depth of economic/social history goes.we have just begun to revisit areas of the debt problems overhanging the global and domestic economies

      • Stefan Jovanovich Says:

        Thx, Ira. For me the question of sovereign IOU defaults is not whether but which. I think Treasuries will be a safe haven for the same reason they were even as U.S. borrowings exploded to pay for the Mexican war. There were no alternatives to be found among the ruins of defaulted State bonds. Are Chicago’s school district bonds really worth the risk for what is a diminished tax premium? They are exempt from Federal tax, but Treasuries are exempt from Illinois tax. Now that Federal IOU rates have become recognizable as current yields, blue State geezers and others are going to be moving towards a “No” answer. Meredith Whitney was not wrong; she was just way too early – which is, of course, the ultimate sin.

  5. Bob Zimmerman Says:

    I believe the Federal Reserve does own some Municipal Bonds. Could you please clarify?

    • Stefan Jovanovich Says:

      In this age of digital currencies the national Treasuries remain the only debtors who can redeem obligations at will by reaching for their keyboards. Everyone else – the State of Illinois, Chicago’s school district – has to find an intermediary. Will Powell and his fellow Governors be willing to buy more munis in the future? Will they have the authority to do so because of the imminence of a default from a muni issuer? My bet is no.

  6. Pierre Chapuis Says:

    I think it was Danille Demartino Booth said, prior to 2007 financial collapse. The brokers that were making millions selling subprime mortgages were taking their profits and buying AAA rated New York city bonds and Berkshire Halthway shares. Just a thought

  7. Stefan Jovanovich Says:

    It took them 3+ years to break even on the BRKA. Treasuries would have been a far less bumpy ride.

  8. GreenAB Says:

    Yra, what do you make of the new Trump tarriffs?

    I´ve already read from Juncker and the Canadians that they won´t tolerate these measures. One counter tarriff from the US trading partners and we´re looking at an escalating trade war. I think the ensuing uncertainty has the potential to kill the bull market.

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