Rescue Me

How transitory is transitory? Maybe inflation won’t turn out to be as “transitory” as we would like, but even the Federal Reserve thinks inflation will ease sometime in the not-too-distant future, likely this year. The bond market certainly doesn’t seem overly concerned about it, with the 10-year Treasury note trading late last week at about 1.75%, or about six percentage points below the current inflation rate. If inflation is such a big problem that must be addressed immediately, shouldn’t long-term bond rates be closer to 5% or 6% rather than less than 2%?

Then why is the Fed all of a sudden so worried about stamping out inflation when it’s also predicting that the inflation rate will come down fairly soon? What’s the rush?

According to its most recent economic projections released after its December 15 monetary policy meeting, the Fed said it expected inflation to fall to 2.6% this year, from 5.3% last year, then fall to 2.3% next year and 2.1% in 2024. Yet now the Fed can’t seem to stamp out inflation fast enough, even though it was Fed policy not too long ago to let inflation “burn hotter for longer.” What happened with that? Continue reading "Rescue Me"

What's Next For The Fed?

Now that the Federal Reserve has formally announced its taper plans, what can we expect next?

The Taper

First of all, let’s not go into panic mode because the Fed is suddenly reducing its asset purchases. In the statement following its November 2-3 meeting, the Fed said it would “begin reducing the monthly pace of its net asset purchases by $10 billion for Treasury securities and $5 billion for agency mortgage-backed securities.” In the scheme of Fed purchases, that’s practically nothing, you won’t even feel it. Indeed, in the very next sentence, the Fed also announced the converse of that, namely that starting this month, it “will increase its holdings of Treasury securities by at least $70 billion per month and of agency mortgage-backed securities by at least $35 billion per month. Beginning in December, the Committee will increase its holdings of Treasury securities by at least $60 billion per month and of agency mortgage-backed securities by at least $30 billion per month.”

Note the operative word, Increase. So yes, it’s accurate to say that the Fed is reducing its asset purchases, but it’s not going away, far from it. It’s still buying a ton of securities. Remember that the Fed’s balance sheet currently totals $8.5 trillion and still growing. Now, the Fed did add that “it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook,” which most market participants take to mean that the Fed is more likely to speed up, not slow down, the pace of purchases, given the current robust state of the economy. That’s a good thing and long overdue. Continue reading "What's Next For The Fed?"

Looking Past Powell

Jerome Powell's term as chair of the Federal Reserve doesn't end until next February, but the handicapping of his reappointment has already begun. A recent poll by the Wall Street Journal found that three-quarters of economists it surveyed believe Powell will be renominated by President Biden, but I would argue that the odds are at best 50-50, if not lower.

Powell has unquestionably been friendly to the financial markets, which counts in his favor on Wall Street, but that may be a detriment when it comes to the progressives who are likely to have the biggest voice in choosing the next Fed chair. Right off the bat, Powell checks off none of the boxes that progressives are looking for, and as he has shown since his inauguration, Biden almost never goes against what they want.

Let’s look at Powell’s negatives: He's a white male. He's a Republican. He comes from Wall Street. He's rich (although most people at this level are). Let's also not forget that Powell was nominated to his position by President Trump, which automatically disqualifies him in the eyes of many, never mind the constant barrage of criticism Trump leveled at him once he was seated.

Just the taint of being associated with the former president should be enough to make him unsuitable for another term.

More importantly, however, Powell has not publicly bought into the prized objectives of the left, namely using the Fed to further social policy (i.e., wealth redistribution) and climate change initiatives, asserting that those are political decisions better left to Congress. Continue reading "Looking Past Powell"

Don't Fear The Taper

Long, long ago, even before the 2008 global financial crisis, the world’s central bankers, including the Fed, shifted their focus from trying to fight inflation to trying to create it. As we know, however, that pursuit of the holy grail of 2% has taken more than a dozen years, and now that we appear to be there, and well beyond it, in fact, the Fed refuses to believe it.

Ever since the economy began reopening earlier this year, the U.S. year-on-year inflation rate has been rising steadily and strongly, well above the Fed’s 2% target. In May, the YOY rise in the consumer price index hit 5.0%, while the core index, which excludes food and energy prices, rose 3.8%. Looking ahead, it’s hard to see inflation easing anytime soon, given the trend in rising worker’s wages, which once on the books are going to be hard to pull back, especially given the dearth of workers relative to job openings. Prices are also rising due to strong pent-up demand that is far outpacing the supply of goods, due partly to the lack of workers.

Yet Fed Chair Jerome Powell continues to insist that this recent surge in inflation is “transitory,” a mere temporary reaction to the economic reopening.

Is he saying that because he really believes it, or because he’s worried what will happen if the Fed starts to turn down the juice, even a little bit, and with a fair warning? Continue reading "Don't Fear The Taper"

The Inevitable Rise In Rates

Consumer Price Index (CPI) Market Scare

A string of robust Consumer Price Index (CPI) readings spooked the markets as a harbinger for the inevitable rise in interest rates. As investors grapple with the prospect of downstream rate increases, pockets of vulnerabilities throughout the market have been exposed. The overall markets have been on a blistering bull run since the November 2020 presidential election cycle. The overall markets as assessed by any historical measure have reached stretched valuations with record risk appetite. As real inflation enters the fray, these frothy markets will come under pressure and possibly derail this raging bull market. Although rising rates may introduce some systemic risk, the financial cohort is poised to go higher. The confluence of rising rates, post-pandemic economic rebound, financially strong balance sheets, and a robust housing market will be tailwinds for the big banks.

Financials

The prospect of rising interest rates coupled with fantastic earnings have propelled bank stocks to all-high highs. Citigroup (C), JPMorgan (JPM), Bank of America (BAC), and Goldman Sachs (GS) have appreciated to all-time highs. Rising interest rates in combination with the highly disruptive COVID-19 backdrop abating has served as the foundation for this move higher. The big banks responded and evolved in the face of COVID-19 to the real possibility of widespread loan defaults, liquidity issues, ballooning credit card debt, and stressed mortgages. To exacerbate these COVID-19 impacts, interest rates, Federal Reserve actions, yield curve inversion, and liquidity heavily weighed on the sector. Continue reading "The Inevitable Rise In Rates"