Premature Victory Laps R Us

Seasoned Kremlinologists are advised to closely study the differences between Wednesday’s statement and that of the previous month (the WSJ’s trusty statement tracker is helpful in this regard). You may notice something peculiar. On the one hand, the October statement exudes a lot of optimism – everything is apparently perfectly fine (shortly before the bottom falls out things usually seem to look fine as well, note though that this is not a comment on timing). The economy is humming! Inflation expectations, though “somewhat lower” than desired, remain “well anchored”. Hurrah!

And yet, the federal funds rate needs to be kept at zilch “for a considerable period of time”. Not only that, once it is actually hiked, it will need to remain “below the level normally considered normal” for a long time as well. And although QE was laid into this ornate coffin of wonderful things happening (like a vampire, it is likely just biding its time, awaiting resurrection), the Fed’s bloated balance sheet is not going to be allowed to shrink. The reinvestment of maturing MBS and treasury debt will continue as before.

Mind, we are not in the least surprised by this particular decision. We don’t think the Fed’s balance sheet has ever been allowed to shrink. Excuse us for not making the effort to confirm this beyond a shadow of doubt, but considering that the Fed’s securities holdings exploded by more than 400% even during the genuine money supply deflation of 1929 to 1933 (so much for “they didn’t do anything” at the time), we think we are on fairly safe ground with this assertion.

So what we have here is a victory lap, combined with a noticeable degree of apprehension. What are they afraid of? Only one thing comes to mind right away: the possible implosion of the bubble they have created. The whole statement sounds a lot like a wink-wink, nudge-nudge to stock market speculators actually.


Interestingly, there was once again a dovish dissent, this time by Narayana Havenstein. He not only protested that the Federal Funds rate should be tied to the zero-bound for about the next two centuries, but that it was premature to end QE as well. Not enough inflation for his taste, as you might guess.

Inflation expectations have indeed been trending downward – this is to say, expectations regarding the future rate of change of CPI. This should actually be viewed as a small consolation, not something to be dreaded. So far, a near doubling of the broad true money supply since 2008 hasn’t affected consumer prices overly much. It has however undoubtedly distorted the economy’s price structure – the bubble in asset prices is one of the more overt signs of this (after all, stocks are titles to capital).

Should consumer price inflation ever enter the scene again, it will be as widely expected as the appearance of Spanish Inquisition, which as is well known, no-one ever expects. Monetary inflation has of course been in high gear for many years now. Here is an update of the situation as of the end of September:


1-TMS-2-absolute,full,annUS broad true money supply TMS-2 as of the end of September – click to enlarge.


2-TMS-2 y-y growth, full,annAlthough the money supply has grown like weeds, its 12 month growth momentum sure isn’t what it once was. While not much has changed on that front since our last update, any decline to lower lows should set off alarm bells – click to enlarge.


Looking for Recessions in all the Wrong Places

Recently a lot of ink has once again been spilled on why a recession and/or a bear market in stocks are allegedly “impossible” at present. Before going into details, we should interpose that we are not making any claims regarding either being imminent, although the risks certainly remain as high as ever. We only want to explain why we believe that the argument that they are not “possible” at this juncture is dubious. We have previously discussed that the assertion that the yield curve must invert before a recession can strike is not even confirmed by historical data (see “The Yield Curve and Recessions” for details). While we buttressed our argument by showing a chart of what has happened in Japan since 1989 (6 recessions in a row of which only the first one exhibited a curve inversion – 25 years ago), the same can be shown by looking at the US economy between 1930 and 1945 – again, 6 recessions in a row occurred without the yield curve inverting even once.


3-Japanese -yield curve and recessions6 recessions in a row in Japan, with a single yield curve inversion occurring prior in the first one that happened a quarter of a century ago – click to enlarge.


It is always a bit risky to rely on historical economic data in making forecasts, but it is certainly a legitimate approach, as long as one remains aware that every slice of economic history is unique (by contrast, economic laws are place- and time-invariantly valid). Forecasting does require one to so to speak don one’s thymological hat. The laws of economics mainly serve as constraints to one’s forecasts. However, in consulting economic history for similarities, one must be careful to pick slices of history that look like they may actually be relevant to the case at hand.

A recent case of myopia in this context has been delivered by former bear, now turned bull, David Rosenberg. We should point out that while Rosenberg has in the past at times evinced a penchant for contrarian thinking, he is a Keynesian at heart (he likes to talk about “output gaps” and Phillips curve type phenomena for instance – shudder!). Mind, Mr. Rosenberg could nevertheless turn out to be right, but if so, it will be for the wrong reasons (i.e., he might just as well have tossed a coin). Rosenberg recently asserted that “unless two specific conditions are present, no bear market can happen”.

When someone makes such an apodictic-sounding statement after the stock market’s CAPE (or Shiller P/E) has reached rarefied heights in the 93rd valuation percentile since 1870 (only slightly bested by 1929, 2000 and 2007), margin debt is close to record highs and market internals have deteriorated sharply for a full seven months, he must offer a very strong special sauce to be convincing. Unfortunately, Rosenberg supports his statement solely with the data of US post WW2 economic history – which we believe is a slice of history that is highly unlikely to be relevant to current events.

In order to illustrate what we mean, consider a few of the most important contingent circumstances differentiating the current era from the rest of of the post WW2 era: total debt in the economy is at nearly 340% of nominal GDP. The most important Federal Reserve-administered interest rate is at an effective 9 basis points, and has by now been stuck there for several years. Could it be that the economy will react slightly different than one in which total debt only amounts to say 160% of GDP and overnight interest rates are at 500 or 600 basis points?

Rosenberg’s argument boils down to the two following points: Firstly, the stock market cannot fall without a “tightening cycle” being initiated by the Fed. Fair enough, let us say this is the case (it isn’t necessarily, by the way). So what is the cessation of $85 billion per month in “QE” if it is not “tightening”? If engaging in QE were not tantamount to a loosening of policy, there would have been no point in doing it from the Fed’s perspective (this is beside the fact that it has not only been a pointless, but downright damaging exercise that will eventually turn out to have severely weakened the economy on a structural basis).

Secondly, the other thing that could bring the market down according to Mr Rosenberg is a recession and he says that “none is in sight”. As far as we are aware, he bases this inter alia on NBER’s leading indicators. However, the behavior of some leading indicators actually changes in times when extreme asset bubbles are underway and a “low inflation” (i.e., low CPI) environment obtains. There is considerable statistical evidence showing that e.g. the stock market turns from a leading to a coincident indicator in such periods, and we have already had two confirmations of this thesis in recent history (2000 and 2007).

We distinctly remember that the majority of mainstream economists was still arguing as late as June 2008 that the US economy would likely avoid a recession. Later, NBER pointed out that the recession had actually already been underway for a full 7 months at the time (its beginning was eventually dated to November 2007 – the stock market peaked in late October of the same year). So most economists won’t even recognize a recession when they are sitting smack dab in the middle of one.

As Zerohedge recently pointed out, research outfit Gavekal believes that the coincident/lagging indicator ratio may actually offer a better gauge of the economy’s strength at this time. Looking at the chart, one could well come to the conclusion that once again, a widely unrecognized recession has begun – a message that would incidentally be congruent with the recent behavior of the treasury bond market (again, it must be remembered that the stock market has failed to “pre-announce” both the 2001-2002 and 2007-2009 recessions):


4-coincident-lagging_recession Coincident-to-lagging index, via Zerohedge/Gavekal.


Finally, below is a chart of Japan’s 90 day CD yields since 1980. Between 1995 and today, there were 5 recessions (accompanied by severe bear markets). Try to spot how many “tightening cycles” in terms of interest rate hikes there were since 1995 and how far they went. Obviously there have been several instances in Japan when a cessation of “QE” was all it took to shove the economy and the stock market over the cliff again.

Mind, we are well aware of the great many things differentiating Japan from the US. We only want to make the point that one cannot assert that no recessions or bear markets are possible unless certain data points follow a specific predetermined script. They may well, but they sure don’t have to. And there are enough differences between the current bubble era and past ones to suggest that things may actually not play out according to the “typical” post WW2 script this time around.


5-Japan-90 day CD rates3-month CD rates in Japan: No big tightening cycles were required to produce Japans last five recessions – click to enlarge.



The Fed has finally buried QE 3. What has nevertheless kept money supply growth on an even keel this year was the creationof fiduciary media by commercial banks, which have especially stepped up their lending to corporations. To this we would note that with corporate net debt already sitting at a record high for quite some time (debt minus cash and cash-equivalent assets), the scope for this type of lending to accelerate seems actually limited. At the same time, the household sector is in the aggregate still licking its wounds from the blowing up of the last bubble, so its members will probably also be hard to persuade to add to their debts. The two areas in which the debt of individuals has been growing strongly are student debt and sub-prime auto debt, both of which have soared. Very likely no additional blood can be squeezed from these turnips either. Chances are therefore good that money supply growth will resume its decline now that “QE” is at least half dead.



Charts by: St. Louis Fed, Zerohedge / Gavekal




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3 Responses to “The FOMC Decision – A Mouthful of Reassurances in Every Conceivable Direction”

  • All-Your-Gold-Are-Mine:

    Of course the Fed has not buried QE at all… the month of October came it at $36.5 Billion addition to the FRB balance sheet and that does not include today. Of course not one “expert” analyst ever asks why, month after month, the Fed balance sheet grows much larger than they stated it would. $36.5 Billion in October… what the f*ck happened to the stated $15 Billion??? More lies we can count on.

  • Mark Humphrey:

    Thanks for your shrewd insight expressed in your commentary today.

    Besides falling T bond rates, various commodity prices are weak, including oil, copper, silver, gold, grains, and others. Also, the real estate market is slowly rolling over, even as mortgage rates are dropping. I think of the real estate market as a vague proxy for the economy. It is built on the issuance of new debt and despite flogging the debt horse, the RE market is drooping.

    Meanwhile, beloved momentum stocks that have been leading the market rally, have hit road bumps. If the market turns out to be coincident in this cycle, the early weakening of Amazon and others might be worth noting.

    • Thanks for the kind words.
      Weakening market internals have actually characterized every rally phase since March, and the recent wobbling of certain momentum stocks just adds to the evidence that not something is not right with the market.
      In a sense, I’m of two minds regarding declining commodity prices: they do indicate that current economic activity is weak and getting weaker (on a global basis). On the other hand, they are helping commodity consumers by lowering their input costs, and as a rule, the resulting positive effect tends to outweigh the negative one on commodity producers. For the short to medium term outlook though it seems more important that commodities prices are a signal of faltering growth in many regions in the world (predominantly the euro area and China).

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