Semi-Annual Fed Report

Today the Fed gave its semi-annual monetary policy report to the Senate. It’s debatable whether any policy changes on interest rates were made because it’s a matter of tone. According to Goldman Sachs the chance of a rate hike in March increased from 15% to 20%. The chance of a rate hike in June increased by 4.8% according to the CME Group FedWatch Tool. This means the tone was hawkish, but not enough to make the market price in more than two rate hikes for the year. Mark Hamrick, the senior economic analyst at Bankrate.com, stated Yellen is sticking with the notion that every meeting is ‘live.’ This is incorrect because March has a 13.3% chance of a rate hike, meaning it is not ‘live.’ I don’t know what specific language the market is looking for to turn March into a live meeting, but if Yellen wanted to, she could have increased those odds with more hawkish language.

The CPI report tomorrow may give us more information on future action, but the Fed can claim it’s letting the economy run hot even if the CPI report shows higher inflation than expected. My contention is that if the Fed can interpret data however it wants; it’s not really data dependent. If inflation were to start ramping, one rate hike per year will no longer suffice.

In the report, the Fed mentioned that valuation pressures increased. The chart the Fed provides is one of the best explanations of how the stock market is in a bubble. It shows the ratio of household net worth to disposable personal income. The series only extends to Q3 2016. If it had the updated metrics for Q4, I think the ratio would achieve a new record high. This chart is a variation of the one which shows the amount of average hourly earnings it takes to earn the value of one share of the S&P 500. However you look at assets, they are too expensive. The wealth is not real. It’s phony wealth created by the Fed. If the Fed wasn’t to blame for this crisis, I think it would be more forward with its fear that assets are overvalued.

weathtoincome

The charts below are not from the Fed, but they explain the excitement which is causing valuations to reach absurd levels. As you can see in the chart on the right, fourth quarter earnings calls had the word “optimism” in them the most since at least 2003. While small vacillations in its usage probably aren’t indicative of anything, the size of the increase along with the hype in the stock market is significant. This is dangerous because it may reverse itself. When I say the optimism won’t last, it’s because an emotional feeling based on nothing isn’t sustainable. When pessimism reigned supreme in late 2008, it didn’t last and that pessimism was rooted it reality as the economy was cratering. Emotional states are the most inconsistent aspect of humanity, so relying on it instead of a strong economy which isn’t overindebted is a dubious proposition.

optimism

It’s questionable why consumers are so optimistic. As you can see in the chart below, they are more indebted now than in any point since this recovery started. Credit card balances grew 6 percent year over year in December. I don’t think mortgage debt will ever reach the level of 2007. The size of the current auto loan bubble is much smaller than the housing bubble of the mid-2000s.

changesinhouseholddebt

On the bright side, nonresidential fixed investment in structures and equipment and intangible capital has started to improve again in the second half of 2016. The economy averted a recession in the second half of last year and likely the first half of this year. I have mistakenly underestimated what optimism can do to the economy. I still standby the idea that it is temporary, but clearly it is powerful enough to boost fixed investments.

fixedinvestment

The Fed meeting caused stocks to rally and bonds to sell off. It’s amusing to see the market rally in the face of the Fed’s comments that asset valuation pressures have increased. It’s like the market is daring the Fed to prick the bubble it created. Yellen can say stock prices are overvalued until she’s blue in the face, but traders won’t start caring unless she plans to act on these worries. The 10-year bond yield rose almost 4 basis points to 2.4716. The 2.6% mark continues to be the key price that needs to be broken to signal a longer term uptrend. As it gets closer to 3%, bonds start to compete more with stocks.

In this presentation, the Fed didn’t discuss the balance sheet. Not discussing the balance sheet is a dovish action. Discussing possibilities of it being unwound is the first step to doing so. This has yet to become a political football which is surprising. The Trump administration appears to be more miffed with the Fed’s international dealings than the QE program. International meetings aren’t what caused this asset bubble. Low interest rates and the $4.5 trillion balance sheet caused it. It will be interesting to see how the Trump administration deals with the Fed because the letter I discussed in an article a few weeks ago seemed to have more anger than substance. The Fed hasn’t changed its behavior since that letter because it didn’t contain any concrete proposals.

Conclusion

            There wasn’t a landmark policy change which came from the Fed’s report to the Senate. That shouldn’t be surprising because the report was on the health of the economy. When the FOMC statement is released everyone already knows how the economy is doing because investors have read the economic reports. The key is to understand how the Fed interprets the data. With this report the Fed is explaining how the economy is doing to help congress understand how to shape fiscal policy. As usual Yellen said the debt is too high. This concern will likely be ignored. Even though the Fed made no change, the market rallied on the report because the market rallies on good news, bad news, and no news.

Spread the love

Comments are closed.