July 2016September 2016Comments
Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate.Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year.FOMC shades GDP up.  They have groupthink and confirmation bias, and thus interpret noise as signal.
Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months. Although the unemployment rate is little changed in recent months, job gains have been solid, on average. Shades up their view on labor.
Household spending has been growing strongly but business fixed investment has been soft.Household spending has been growing strongly but business fixed investment has remained soft.No change.
Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.No change.
Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.No change.  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.65%, uunchanged from July.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen.The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further.No change.
Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.No change. CPI is at +1.1% now, yoy.
Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments.Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.Interesting change.  Indicates that near-term risks have risen in their view.  I think the risks are higher than they do, but I don’t see it has shifted in the last two months.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No change.
 The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.New sentence.  Makes a bow to the hawks, but does not go with them, forgetting monetary policy lags.
The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.  Think of monetary policy as a drug for which a tolerance gets built up.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.No change.  Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo.Note that the permanent members are all on board with the dovish policy.  I’m surprised that Bullard is with them.
Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.Three regional Fed Presidents voted to tighten policy.  9-3 votes or higher disagreements are relatively rare, since votes have been announced since the mid-1980s.

 

Comments

  • The FOMC tilts closer to tightening, though they changed their risk statement to neutral.
  • Interesting to see such a large dissent. That is a relatively rare occurrence.
  • Policy continues to stall, as the economy muddles along.
  • But policy should be tighter. Savers deserve returns, and that would be good for the economy.
  • The changes for the FOMC’s view are that GDP and labor indicators are stronger. The FOMC has groupthink and confirmation bias, and thus interpret noise as signal.
  • Equities and bonds rise. Commodity prices rise and the dollar falls.  Everything is a little looser.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

June 2016July 2016Comments
Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up.Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate.FOMC shades GDP down and employment up, which is the opposite of last time.
Although the unemployment rate has declined, job gains have diminished.Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months. Sentence moved up in the statement.  Expresses less confidence in the labor market.
Growth in household spending has strengthened. Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft.Household spending has been growing strongly but business fixed investment has been soft.Drops comments on the housing sector and net exports.
Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.No change.
Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.No change.  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.65%, up 0.18% from March.  Undid the significant move from earlier in 2016.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen.The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen.No change.
Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.No change. CPI is at +1.1% now, yoy.
The Committee continues to closely monitor inflation indicators and global economic and financial developments.Near-term risks to the economic outlook have diminished. The Committee continues to closely monitor inflation indicators and global economic and financial developments.No change.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.  Think of monetary policy as a drug for which a tolerance gets built up.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.No change.  Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Back to a small dissent.
 Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.Our favorite dissenter returns.

 

Comments

  • This statement was a nothing-burger.
  • Policy continues to stall, as the economy muddles along.
  • But policy should be tighter. Savers deserve returns, and that would be good for the economy.
  • The changes for the FOMC’s view are that labor indicators are stronger, and GDP and household spending are weaker.
  • Equities and bonds rise a little. Commodity prices rise and the dollar falls.  Everything is a little looser.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

Picture Credit Bloomberg

Picture Credit: Bloomberg

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Rates can go lower from here.  For as long as I can remember, I have been told by many experts that rates can’t go lower, or, that they must go up — there is no way they can go lower.  I have argued with that idea, as has Hoisington (Lacy Hunt), Gary Shilling and a few others.

Note also that the Fed and most central banks have been on the wrong side of this as well.  They keep saying that inflation will come, economic activity will pick up, and that interest rates will rise.

The Fed keeps saying that they will tighten policy.  I’ll tell you this — with only 0.82% between the yields on 10- and 2-year Treasuries, the Fed is not tightening.

WIth debt levels as high as they are (both government and private), trying to influence economic activity though interest rates is a dumb idea.  Incenting borrowers to borrow more is difficult, aside from the government — and they rarely do anything with the money that helps produce opportunities for greater economic activity.

We would be better off without “policymakers” trying to “stimulate” the economy, “manage” it, “stabilize” it, etc.  (But where is the political will to change things — the populace wants easy prosperity, and who is there to tell them to accept a rough world where work and competition is tough, and there is no “Big Daddy” to make life easy?  The people are the problem.  The politicians are only a symptom.)

There is one thing that could change this, but it would lay bare the intellectual and moral bankruptcy of what policymakers have been trying to do, which is try to maintain the real value of debt claims while still trying to “stimulate” the economy.  They could burn away the value of debt claims through an inflation greater than that of the 1970s.

So far, they aren’t willing to do that.  But their existing policies will prolong the stagnation.

And as such, rates can fall further — with a lot of noise/variation around it.

Picture Credit: Peanuts Reloaded || Perhaps today Brexit; Monday an exit from Italy or Spain; [then] Europe dismantles

Picture Credit: Peanuts Reloaded || Roughly: “Perhaps today Brexit; Monday an exit from Italy or Spain; [then] Europe dismantles”

=-==-=-=-=-=-=-=-=-=-=-=-=-=-==-=-

At a time like this, when the Brexit Boogeyman goes “Boo!” it’s time to take stock of the situation amid panic.

Though the UK will face some political unrest as the Prime Minister resigns, and article 50 is likely but not certainly invoked, the nature of political discourse hasn’t shifted in full.  Though an important question, it is only one question, and more things will remain stable than change.

At least that is most likely.  If you think of “real options” theory, you could say, “Okay, a door opened today that was previously locked.  What new doors beyond that one could be opened?”  Other countries could leave the EU and/or Eurozone [EZ].  The EU/EZ could dissolve.  The odds of other countries leaving isn’t that high.  For the EU or EZ to dissolve would take a lot of doing, and the odds of that happening is very low, though higher than the odds yesterday.

As I said a week ago:

Governments are smaller than markets; markets are smaller than cultures.

What I am saying is that almost everything affecting the needs of people will get done when there is sufficient freedom.  If Brexit occurs, the UK will negotiate some agreement that is mutually beneficial to the UK and the EU, and most things will go on as they do today.  Even with a subpar agreement, perfidious Albion is very effective at getting what they need completed.  This is especially true of their very effective and creative financial sector in the City of London without which most effective international secrecy, taxation avoidance and regulatory avoidance business could not be done.

Whatever happens, it will happen slowly.  Leaving a complex multinational group like the EU takes two years at least.  How it all works out in detail is not predictable.

I can say that human systems tend toward stability.  People act to preserve the things that they like.  Only under severe conditions does that cease to be true, and even then typically only for short periods of time.

I can also say something a little more controversial.  Wealth, assets, and money [WAM] act like they are alive and have more votes than people do under most conditions.  Why am I saying this?

Governments come in, and go out, but for the most part, the same things get done.  Those thinking that radical change will come are usually deeply disappointed.  WAM tend to maintain the status quo, not because their owners bribe politicians and suborn regulators pay political action contributions,  but because people want the streams of goods and services that help make WAM valuable.  Only a genuine crisis at least as large as the Great Depression or the Civil War can create truly radical change that reshapes the basic desires of most of the people in a nation.

Capitalist democracies that respect the rule of law (e.g., the government is also governed by a higher law) are usually pretty stable; systems that don’t have significant capitalism or democracy may last a couple generations, but tend to fall apart.

All that said, there is significant economic pressure to do two things after the Brexit:

  • Rethink the single currency and common laws
  • Maintain a free-ish trade zone in goods and services

The Eurozone does not allow for the necessary economic adjustments across nations in a fiat monetary system.  Nations need their own currencies, central banks, etc.  They also need to govern themselves via their local culture, not someplace far away with misguided idealists who think they know what’s best for all.

Free-ish trade maintains most of what is needed for human needs.  The European Union is a political construct meant to prevent war from ever recurring in Europe.  The best way to do that is through trade.  Severe wars rare start between nations that rely on each other and interact through commerce.

My view is that ten years from now, the goods and services that people want will get delivered, regardless of the governmental structures in Europe.  I will invest accordingly.

Practical Implications

Things will be rocky in the short run, and there will be more bumps along the road as the Brexit negotiations go on.  I will be resisting panic and euphoria in modest ways.  This isn’t the sum total of my strategies, but I expect that profitable business will continue, and that people and nations will pursue generally intelligent long-term self-interest as events unfold.

When I say modest, I tweak my portfolios at the edges.  Brexit does not comprise more than 5% of what I would do with assets.  As with any investment idea, spread your bets, diversify, don’t bet the farm.

And, I would say the same even to governments — if you don’t have contingency plans for the possibility of the EU shrinking or even disappearing, you are not truly prepared for all contingencies.  As Warren Buffett once said (something like) “We’re paid to think about the things that ‘can’t happen.'”

In closing, many thought that Brexit could not happen.  Now, what else “can’t happen?” 😉

When do you admit that you are wrong?  Do you do it publicly?  Do you hide it?

Do you hide it plain sight?

When I look at the graph for Fed funds for 2017 and later, I think the FOMC is admitting that they were wrong for a long time, and now hide that in plain sight.

They don’t admit that they were wrong.  They don’t admit that the economy has proven to be a lot weaker than they ever expected, and that they now expect that to persist for a while.

That’s what the graphs for Fed funds and GDP say.

central tendency_GDP

But what does the FOMC say in its statement?  It expresses confidence in future GDP robust growth, even though their expectations have collapsed to 2% real growth as far as they care to opine.

Look at the above graph, and see how it has all converged to 2%.

central tendency_PCE

PCE Inflation? They assume it will be 2% before the year starts, and then they adapt to incoming data.

There’s no model here, just a disappointed ideology that says they wish to  produce a 2% PCE inflation rate, dubious as that goal is.

The only thing more dubious there is their ability to achieve their ideology.

central tendency_Unemp

Remember after the financial crisis? There were those who said unemployment would never return to 5% — that the natural rate of unemployment was permanently higher.

I may have been among them.

Well, now the FOMC has a new consensus.  Unemployment below 5% as far as they care to opine.

When I look at these graphs, particularly the ones for Fed funds and GDP growth, I see a paradigm shift where Bayesian priors have been dragged kicking and screaming by the data to No Man’s Land.

Grudgingly they acknowledge the data in the graphs, but they don’t have a theory to go along with it, so their statements and minutes sound the same.

Nothing is changed.  Soon our policies will restore robust real GDP growth, produce inflation and then we will tighten policy and restore normalcy.

Well, that’s what their minutes and statements say.

But who are you going to believe?  The FOMC and their words, or your lying eyes looking at their graphs?

PS — modified to reflect Bullard’s lack of a vote on long-term Fed funds rate.

=-=-=-=-

April 2016June 2016Comments
Information received since the Federal Open Market Committee met in March indicates that labor market conditions have improved further even as growth in economic activity appears to have slowed.Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up.FOMC shades GDP up and employment down, which is the opposite of last time.
 Although the unemployment rate has declined, job gains have diminished.Sentence moved up in the statement.  Expresses less confidence in the labor market.
Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high.Growth in household spending has strengthened.Shades up household spending.
Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft.Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft.Shades up net exports.
A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Sentence moved up in the statement.
Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and falling prices of non-energy imports.Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports.No change.
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.No change.  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.48%, down 0.25% from March.  Undid the significant move from earlier in 2016.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will strengthen.No change.
Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.No change. CPI is at +1.1% now, yoy.
The Committee continues to closely monitor inflation indicators and global economic and financial developments.The Committee continues to closely monitor inflation indicators and global economic and financial developments.No change.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.  Think of monetary policy as a drug for which a tolerance gets built up.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.No change.  Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Back to unanimity in the monoculture of neoclassical economics.
Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent. Say bye to the small dissent.

Comments

  • The FOMC meets too frequently. Often the economic signals at one meeting get reversed at the next meeting, as was true this time.  Rather than hyper-interpreting every wiggle, maybe the FOMC should meet every six months, with the proviso that the chairman could call an interim meeting if the situation demanded it.
  • That this is true regarding economic aggregates has been known since the ‘50s. For a variety of reasons, it is difficult to distinguish signal from noise over periods of less than a year.
  • Then again, maybe the FOMC meets to make it look like they are doing something. 😉
  • This statement was a nothing-burger.
  • Policy continues to stall, as the economy muddles along.
  • But policy should be tighter. Savers deserve returns, and that would be good for the economy.
  • The changes for the FOMC’s view are that labor indicators are weaker, and GDP and household spending are stronger.
  • Equities fall and bonds rise a little. Commodity prices rise and the dollar falls.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

Photo Credit: duncan c || It wasn't my intent initially to compare the words of the FOMC with the scrawlings of a vandal, but ya know some things are surprise fits

Photo Credit: duncan c || It wasn’t my intent initially to compare the words of the FOMC with the scrawlings of a vandal, but ya know, some things are surprise fits

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I wasn’t surprised to hear in the FOMC minutes that members of the committee thought:

For these reasons, participants generally saw maintaining the target range for the federal funds rate at 1/4 to 1/2 percent at this meeting and continuing to assess developments carefully as consistent with setting policy in a data-dependent manner and as leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting.

and

Participants agreed that their ongoing assessments of the data and other incoming information, as well as the implications for the outlook, would determine the timing and pace of future adjustments to the stance of monetary policy. Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June. Participants expressed a range of views about the likelihood that incoming information would make it appropriate to adjust the stance of policy at the time of the next meeting. Several participants were concerned that the incoming information might not provide sufficiently clear signals to determine by mid-June whether an increase in the target range for the federal funds rate would be warranted. Some participants expressed more confidence that incoming data would prove broadly consistent with economic conditions that would make an increase in the target range in June appropriate. Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.

I was surprised to see some of the markets take it seriously.  Here’s why:

1) The FOMC loves to talk hawk and them be doves.  They don’t think the costs to waiting are significant, particularly given how low measured inflation and and implied future inflation are.  Five-year inflation, five years forward implied from TIPS spreads is not high at present as you can see here:

2) The FOMC is well known for giving with the right hand and taking with the left.  They would like if possible to have the best of both worlds — gentle movement of what they view as key variables, while usually not dramatically changing the forward estimates of those

3) The FOMC’s natural habitat is wishful thinking.  Their GDP forecasts are usually high, and they suspect their policy tools will move the economy the way they want and quickly, and it’s just not true.

4) LIBOR rates have done a better job of the FOMC at estimating future policy, and they have barely budged since the FOMC minutes came out.

5) The FOMC always has more doves than hawks, and that is the way the politicians who appoint and approve the board members like it.  They will live with inflation.  That was yesterday’s problem.  Today’s problem is stagnant median incomes — and looser monetary policy will help there, right?

Well, no, but I’m sure they clapped when Peter Pan asked them to save Tinkerbell.  There is no link between inflation and faster real growth over the long haul.  There may be measurement errors in the short run.

6) They don’t like moving against foreign rates, but that’s not a big factor.

7) GDP isn’t showing much lift at all.

Summary

Unless we have a change in management at the Fed, where they are not trying to manipulate markets through their words, but maybe one that said little and acted quietly, like the pre-1986 FOMC, they really aren’t worth listening to.  They act like politicians.  Let them study Martin and Volcker, and learn from when the FOMC was more effective.

PS — I’m not saying they can’t tighten in June.  I’m just saying it’s unlikely, and to ignore the comments in the FOMC minutes.  What the FOMC says is of little consequence.  It’s what they do that counts.  They are like a little dog that barks a lot, but rarely bites.

This is the fourth article in this series, and is here because the S&P 500 is now in its second-longest bull market since 1928, having just passed the bull market that ended in 1956.    Yeah, who’da thunk it?

This post is a little different from the first three articles, because I got the data to extend the beginning of my study from 1950 to 1928, and I standardized my turning points using the standard bull and bear market definitions of a 20% rise or fall from the last turning point.  You can see my basic data to the left of this paragraph.

Before I go on, I want to show you two graphs dealing with bear markets:

As you can see from the first graph, small bear markets are much more common than large ones.  Really brutal bear markets like the biggest one in the Great Depression were so brutal that there is nothing to compare it to — financial leverage collapsed that had been encouraged by government policy, the Fed, and a speculative mania among greedy people.

The second graph tells the same story in a different way.  Bear markets are often short and sharp.  They don’t last long, but the intensity in term of the speed of declines is a little more than twice as fast as the rises of bull markets.  If it weren’t for the fact that bull markets last more than three times as long on average, the sharp drops in bear markets would be enough to keep everyone out of the stock market.

Instead, it just keeps many people out of the market, some entirely, but most to some degree that would benefit them.

Oh well, on to the gains:

Like bear markets, most bull markets are small.  The likelihood of a big bull market declines with size.  The current bull market is the fourth largest, and the one that it passed in duration was the second largest.  As an aside, each of the four largest bull markets came after a surprise:

  1. (1987-2000) 1987: We knew the prior bull market was bogus.  When will inflation return?  It has to, right?
  2. (1949-56) 1949: Hey, we’re not getting the inflation we expected, and virtually everyone is finding work post-WWII
  3. (1982-7) 1982: The economy is in horrible shape, and interest rates are way too high.  We will never recover.
  4. (2009-Present) 2009: The financial sector is in a shambles, government debt is out of control, and the central bank is panicking!  Everything is falling apart.
Sometimes you win, sometimes you lose...

Sometimes you win, sometimes you lose…

Note the two dots stuck on each other around 2800 days.  The arrow points to the lower current bull market, versus the higher-returning bull market 1949-1956.

Like bear markets, bull markets also can be short and sharp, but they can also be long and after the early sharp phase, meander upwards.  If you look through the earlier articles in this series, you would see that this bull market started as an incredibly sharp phenomenon, and has become rather average in its intensity of monthly returns.

Conclusion

It may be difficult to swallow, but this bull market that is one of the longest since 1928 is pretty average in terms of its monthly average returns for a long bull market.  It would be difficult for the cost of capital to go much lower from here.  It would be a little easier for corporate profits to rise from here, but that also doesn’t seem too likely.

Does that mean the bull is doomed?  Well, yes, eventually… but stranger things have happened, it could persist for some time longer if the right conditions come along.

But that’s not the way I would bet.  Be careful, and take opportunities to lower your risk level in stocks somewhat.

PS — one difference with the Bloomberg article linked to in the first paragraph, the longest bull market did not begin in 1990 but in 1987.  There was a correction in 1990 that fell just short of the -20% hurdle at -19.92%, as mentioned in this Barron’s article.  The money shot:

The historical analogue that matches well with these conditions is 1990. There was a 19.9% drop in the S&P 500, lasting a bit under three months. But the damage to foreign stocks, small-caps, cyclicals, and value stocks in that cycle was considerably more. Both the Russell and the Nasdaq were down 32% to 33%. You might remember United Airlines’ failed buyout bid; the transports were down 46%. Foreign stocks were down about 30%.

And then Saddam Hussein invaded Kuwait.

That might have been the final trigger. The broad market top was in the fall of 1989, and most stocks didn’t bottom until Oct. 11, 1990. In the record books, it was a shallow bear market that didn’t even officially meet the 20% definition. But it was a damaging one that created a lot of opportunity for the rest of the 1990s.

FWIW, I remember the fear that existed among many banks and insurance companies that had overlent on commercial properties in that era.  The fears led Alan Greenspan to encourage the FOMC to lower rates to… (drumroll) 3%!!!  And, that experiment together with the one in 2003, which went down to 1.25%, practically led to the idea that the FOMC could lower rates to get out of any ditch… which is now being proven wrong.

Caption from the WSJ: Regulators don’t think it is the place of Congress to second guess how they size up securities. Fed Chairwoman Janet Yellen said recently that legislation would “interfere with our supervisory judgments.” PHOTO: BAO DANDAN/ZUMA PRESS

PHOTO CREDIT: BAO DANDAN/ZUMA PRESS

March 2016April 2016Comments
Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Information received since the Federal Open Market Committee met in March indicates that labor market conditions have improved further even as growth in economic activity appears to have slowed. FOMC shades GDP down and employment up.
Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft.Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high. Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft.Shades down household spending.
A range of recent indicators, including strong job gains, points to additional strengthening of the labor market.A range of recent indicators, including strong job gains, points to additional strengthening of the labor market.No change.
Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports.Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and falling prices of non-energy imports.Shades energy prices up, and prices of non-energy imports down.
Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.No change.  TIPS are showing higher inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 1.73%, up 0.08% from March.  Significant move since February 2016.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.No change. Any time they mention the “statutory mandate,” it is to excuse bad policy.
The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.No change.
However, global economic and financial developments continue to pose risks.They moved this down two sentences, sort of, as global markets are calmer.
Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.No change. CPI is at +0.9% now, yoy.

Shades inflation down in the short run due to energy prices.

The Committee continues to monitor inflation developments closely.The Committee continues to closely monitor inflation indicators and global economic and financial developments.Adds in monitoring of global economics and finance.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent.No change.
The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.No change.  They don’t get that policy direction, not position, is what makes policy accommodative or restrictive.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.No change.
This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.No change.  Gives the FOMC flexibility in decision-making, because they really don’t know what matters, and whether they can truly do anything with monetary policy.
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.No change.  Says that they will go slowly, and react to new data.  Big surprises, those.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.No change.  Says it will keep reinvesting maturing proceeds of agency debt and MBS, which blunts any tightening.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.No change. Not quite unanimous.
Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.One lonely voice that can think past the current consensus of neoclassical economists.

Comments

  • Policy continues to stall, as the economy muddles along.
  • But policy should be tighter. Savers deserve returns, and that would be good for the economy.
  • The changes for the FOMC’s view are that labor indicators are stronger, and GDP and household spending are weaker.
  • Equities rise and bonds rise. Commodity prices flat and the dollar falls.
  • The FOMC says that any future change to policy is contingent on almost everything.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain’t moving rates up much, absent much higher inflation, or a US Dollar crisis.

Idea Credit: Philosophical Economics Blog

Idea Credit: Philosophical Economics, but I estimated and designed the graphs

There are many alternative models for attempting to estimate how undervalued or overvalued the stock market is.  Among them are:

  • Price/Book
  • P/Retained Earnings
  • Q-ratio (Market Capitalization of the entire market / replacement cost)
  • Market Capitalization of the entire market / GDP
  • Shiller’s CAPE10 (and all modified versions)

Typically these explain 60-70% of the variation in stock returns.  Today I can tell you there is a better model, which is not mine, I found it at the blog Philosophical Economics.  The basic idea of the model is this: look at the proportion of US wealth held by private investors in stocks using the Fed’s Z.1 report. The higher the proportion, the lower future returns will be.

There are two aspects of the intuition here, as I see it: the simple one is that when ordinary people are scared and have run from stocks, future returns tend to be higher (buy panic).  When ordinary people are buying stocks with both hands, it is time to sell stocks to them, or even do IPOs to feed them catchy new overpriced stocks (sell greed).

The second intuitive way to view it is that it is analogous to Modiglani and Miller’s capital structure theory, where assets return the same regardless of how they are financed with equity and debt.  When equity is a small component as a percentage of market value, equities will return better than when it is a big component.

What it Means Now

Now, if you look at the graph at the top of my blog, which was estimated back in mid-March off of year-end data, you can notice a few things:

  • The formula explains more than 90% of the variation in return over a ten-year period.
  • Back in March of 2009, it estimated returns of 16%/year over the next ten years.
  • Back in March of 1999, it estimated returns of -2%/year over the next ten years.
  • At present, it forecasts returns of 6%/year, bouncing back from an estimate of around 4.7% one year ago.

I have two more graphs to show on this.  The first one below is showing the curve as I tried to fit it to the level of the S&P 500.  You will note that it fits better at the end.  The reason for that it is not a total return index and so the difference going backward in time are the accumulated dividends.  That said, I can make the statement that the S&P 500 should be near 3000 at the end of 2025, give or take several hundred points.  You might say, “Wait, the graph looks higher than that.”  You’re right, but I had to take out the anticipated dividends.

The next graph shows the fit using a homemade total return index.  Note the close fit.

Implications

If total returns from stocks are only likely to be 6.1%/year (w/ dividends @ 2.2%) for the next 10 years, what does that do to:

  • Pension funding / Retirement
  • Variable annuities
  • Convertible bonds
  • Employee Stock Options
  • Anything that relies on the returns from stocks?

Defined benefit pension funds are expecting a lot higher returns out of stocks than 6%.  Expect funding gaps to widen further unless contributions increase.  Defined contributions face the same problem, at the time that the tail end of the Baby Boom needs returns.  (Sorry, they *don’t* come when you need them.)

Variable annuities and high-load mutual funds take a big bite out of scant future returns — people will be disappointed with the returns.  With convertible bonds, many will not go “into the money.”  They will remain bonds, and not stock substitutes.  Many employee stock options and stock ownership plan will deliver meager value unless the company is hot stuff.

The entire capital structure is consistent with low-ish corporate bond yields, and low-ish volatility.  It’s a low-yielding environment for capital almost everywhere.  This is partially due to the machinations of the world’s central banks, which have tried to stimulate the economy by lowering rates, rather than letting recessions clear away low-yielding projects that are unworthy of the capital that they employ.

Reset Your Expectations and Save More

If you want more at retirement, you will have to set more aside.  You could take a chance, and wait to see if the market will sell off, but valuations today are near the 70th percentile.  That’s high, but not nosebleed high.  If this measure got to levels 3%/year returns, I would hedge my positions, but that would imply the S&P 500 at around 2500.  As for now, I continue my ordinary investing posture.  If you want, you can do the same.

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PS — for those that like to hear about little things going on around the Aleph Blog, I would point you to this fine website that has started to publish some of my articles in Chinese.  This article is particularly amusing to me with my cartoon character illustrating points.  This is the English article that was translated.  Fun!