The Fed's Policy Situation

Summary Of Fed Policy

The chart below is a great summary of the monetary policy situation. It shows the S&P 500, the current Fed balance sheet, the future balance sheet, the Fed funds rate, the Fed funds futures, the long term expectations, and the dot plot.  Now that stocks have done well for a couple years since the end of QE, I think the calls for a selloff just because QE is over, will end. The new calls for a selloff will occur when the global QE starts to end next year. Don’t be fooled into thinking this policy means a bear market is coming. It’s a possibility, but it needs to be put in context with how the economy is doing, the risk appetite investors have, and where earnings are headed. I’m not saying the balance sheet isn’t important. It’s that no indicator is the absolute truth on where stocks are headed. Many indicators have had a far longer track record of high correlation with the stock market, but that doesn’t mean you just go with what they say. Investing is both an art and a science.

As you can see, the Fed funds curve is very close to the dot plot in the next 12 months. In 2019 and 2020, the dot plot is higher than the Fed funds futures. This shows how the Fed will need to give in to the market by becoming more dovish. The other possibility is inflation picks up which causes the Fed futures to pick up. Also, the Fed could just try to use guidance to move the curve higher. That could potentially flummox the market. However, it’s not that big of a difference unless the Fed plans on going with what its most hawkish members want. As you can see, the decline in inflation has caused the Fed to lower it’s long term projection substantially. The long term rate started to become closer to reality right before the Fed started raising rates. Lowering the long term rate matters more because the Fed is in the hiking cycle. The Fed will probably end the hikes this cycle somewhere between 1.80% and 2.75%.

Where Is The Volatility?

When answering the question of where the volatility in stocks has gone, some say the economy and earnings are good so stocks shouldn’t go down. However, that explanation doesn’t answer why volatility is down in gold, currencies, and fixed income. The chart below depicts an interesting situation. It shows the volatility in some of the cryptocurrencies as compared to the volatility in the S&P 500. As you can see, the S&P 500 volatility doesn’t come close to the volatility in the cryptocurrencies. It’s possible to conclude the volatility has moved out of traditional assets and into cryptocurrencies. This implies the two categories of assets are related. Some argue that if the crypto space suffers a crash, there won’t be any effects in other assets. I disagree with this notion. All money is connected. If there are major losses in the crypto space, I think there will be effects seen in other asset classes such as stocks. The total market cap of all the cryptocurrencies is about $200 billion. It’s the size of a large cap company. The bigger it gets, the worse the effect a crash will have on other traditional assets.

The Chinese Consumer Is Mirroring American’s

If you looked at a short term chart of the Chinese consumer confidence indicator, it would look just like America. As you can see, the Chinese consumer is very optimistic as the Singles Day approaches on November 11th. That’s the best day of the year for e-commerce sales. It’s like a combination of (Amazon) Prime Day and Cyber Monday in America. Last year, the Chinese consumers spend $17.8 billion online on Singles Day. That’s several times larger than Black Friday in America. Black Friday and Cyber Monday had just over $4 billion in sales combined in 2016. As you can see, if you were to try to make up the perfect economic scenario, you’d come close to what we have now as both the Chinese and the American consumer confidence indexes are the highest in over 10 years.

New Fed Chair

As you know, President Trump picked Powell as Fed chair. He’s a lock to get confirmed by the Senate, in my opinion, because the 2013 rule change means he only needs to get 51 votes. There will be headlines when he is questioned by Congressional officials. As a pragmatist, he will likely do fine. The fiercest questions might come from the Republicans who wanted Taylor or Warsh to be picked. There will be a few Democrats who vote for Powell because he was nominated to the Board of Governors by President Obama. When he was confirmed by the Senate both times only one of the votes against him was by a Democrat. The first step will be for him to testify in front of the Senate Banking Committee where he will need a majority to support him before he goes up for a vote to be confirmed by the Senate.

The chart below shows the economic performance before and after Fed chairs are picked. It’s interesting to see how Burns, Miller, and Greenspan saw growth improve after their terms started, but all three are considered to have done a bad job. Burns was unduly influenced by politics, Miller wasn’t able to properly fight inflation and had little monetary policy experience, and Greenspan helped create the housing bubble. Bernanke and Yellen are thought of as successes because stocks rose and the economy started to recover under them. The next few years will probably be thought of as Yellen and Bernanke’s legacy more than Powell’s if the same policies are pursued. The next recession might even be blamed on them if it is found out that rates were kept too low for too long. We can’t say for sure what Powell’s leadership will bring since he hasn’t testified yet. These statements and the first Fed meeting in 2018 will be focused on extensively by the media and investors.

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