By John Mauldin
There is an obsession in the marketplace over the date when the Fed will once again begin to raise rates. As if another 25 basis points is going to change the economics on tens of trillions of dollars of investments. But as we reflect on the issue more deeply, it becomes obvious that a minor bump in the fed funds rate will indeed change a great deal of economics all over the world.
No, it won’t do much to the cap rate on your latest real estate purchase, but it is likely to greatly affect the pricing of the currency and commodity markets. And those markets will affect corporate profits, which will affect the stock market. It’s all connected.
And what if the Fed has lost control? What if they are in a no-win situation where raising rates will cause reactions they don’t want, but not raising rates will result in equally unpleasant reactions?
A big part of the problem lies in what we analysts call divergent and convergent monetary policies. With Japan mounting an unprecedented quantitative easing attack on currencies everywhere and Europe getting ready to join in, with smaller nations all over the world lowering their interest rates, if the US were to raise rates, that move would strengthen the dollar even more. But that would mean even more deflation imported into the US.
Today we find that the headline CPI was -0.7% for January, coming on the heels of two previous months at -0.3%. The year-over-year rate slipped into negative numbers for the first time since October 2009, when we were still reeling from a deep recession.
The Fed typically raises rates when it wants to lean into inflation, not when inflation is falling. Yes, I know that Yellen in her testimony and in recent Fed releases has said the Fed is confident that inflation will once again rise to 2%. And that, even if you take out food and energy, inflation has still risen at 1.6% over the last 12 months.
I want to thank Joan McCullough for allowing me to use the essay she wrote yesterday morning, which is the single best description of the dilemma facing the Federal Reserve that I’ve read in some time. It’s not all that long, and it has Joanie’s irreverent humor sprinkled liberally throughout, so it’s not only a short read, it’s fun.
So our economy will be impacted negatively not by official interest rates; the multinationals also come to mind for the stock pickers. Because we already know that the entire interest-rate, fiscal position, underlying economic metrics relationship has been decommissioned. By the tidal wave of printed money. That has us comin’ and goin’ at the moment. With the present “beneficiary,” the US Dollar. We started it. We flooded it. We yanked it back. It’s their turn now.
The situation with the Fed and its impact on the global economy is starting to get really interesting. I am really looking forward to my conference, where I will have both those who believe the Fed can control things and others who are equally convinced that the world is about to change profoundly no matter what the Fed does. I intend to get them up on the stage together and throw them raw meat – like the piece you are going to read today – and see what ensues. It will be fun theater; but even more importantly, it will help us understand the realities of the world we live in.
You can still get the early-bird pricing for this year’s Strategic Investment Conference by going to this link. You really do want to try to get to this conference.
We actually had a little bit of winter here in Texas this past week. Not a whole lot, but ice and snow, and enough to close the schools for a few days, so all the kids were happy. But we still had a good-sized gathering on Monday when I invited the boards of the various Ashford companies, which are all involved with hotel REITs in one way or another. Full disclosure: I have joined the board of Ashford Inc., partly because Monty Bennett is my very good friend and fun to work with, and partly because it exposes to me to a business that is very sensitive to the economy and thus gives me a little more insight into what’s really happening in the world. There has been a great deal to learn about Ashford’s business, and it’s been quite fun.
I am on one other public board (Galectin Therapeutics or GALT), and the two businesses could hardly be more different. And then I think what it would be like to be involved with any number of other interesting businesses I’m familiar with, and I realize again the enormous complexity of our capitalist system. I am invited to speak at various corporate gatherings and board meetings from time to time and try to learn a little bit about their industries when I have the opportunity. I remember speaking to a group that did what was basically property insurance, which I thought was mundane going in. Then in the course of interacting with them I realized that there were 1,000 intricate moving parts necessary to simply allow me to have property insurance. And the mind boggles at what it takes to bring some of the technology that’s on my desk to the marketplace, let alone to sell it substantially more cheaply every year.
Every bit of the far-flung capitalist enterprise has to be executed against the backdrop of the Federal Reserve’s manipulating the marketplace, screwing (that’s about as nice a term as one should use in referring to financial repression) savers and fixed-income investors, creating chaos in the pension fund world, and roiling the currency markets with their decisions. Seventeen people sitting around a table thinking they have enough understanding to set interest rates for a market of one million companies whose complexities are staggering. The mind reels.
The good news is that I will get to ponder some of this while reading a book by the pool in Orlando this weekend, where I’ll speak on behalf of my friends at Altegris Investments to the American Bankers Association, yet another extremely complex business. Have a great week and look for my letter over the weekend, where we will further explore the explosion of debt in the world over the last eight years.
Your getting off his soapbox analyst,
John Mauldin, Editor
Outside the Box email@example.com
Shovelin’ Schmitt Against the Tide
By Joan McCullough
I used to be quite sure that raising rates was a sure-fire way of slowing an economy.
Given the worldwide printing orgy currently being staged by the central banks … with China reiterating a need for more participation overnight … I wonder now. If official rates amount to a tinker’s dam.
You remember official rates, right? Often called “base rates” because it was upon this first step that the cost of money going forward was supposed to be priced.
But the size of the largesse both extant and anticipated is such that the protocols as we knew them have been battered into nonexistence.
So given the investor response to the printing jamboree which has become frenzied to the extent that Germany is negative now out thru 7 years. And 10-year paper issued by the Portuguese government is trading this a.m. at least 10 bps cheaper than the yield on US paper. I wonder aloud if the entire relationship between interest rates, fiscal position and underlying economic metrics has not been permanently abolished. As the seemingly never-ending flow of printed money has out of necessity crowding out … overflowed into corporate issuance from investment grade right on down to toilet paper. Blurring all lines as the ability to assign value has likewise been washed away in the flood.
The visual is of a tidal wave; origin an unnecessary detail. Flowing around the global markets. Hot spots, of course, are the currently-targeted sovereign issues with overflow driven by gravity at this stage.
These thoughts occurred to me having reread Yellen’s testimony and reviewed the Q&As which followed both days.
Conclusion: Let there be no further pretense of the superiority of any US recovery; any pretense about the effectiveness of ZIRP and QE are likewise dispensed with.
The FED is about to be hoisted way high up. By its own petard.
They had one tool left for all intents and purposes. The tinkering with interest rates.
So as the global currency war went full swing, they had the option of accepting the deflation being sent their way by the other sovereigns or deflecting it.
To accept the deflation, they would tighten. To deflect it, they would ease. Standing pat? While under suspicion of a tightening bent or when backing away from same during Congressional testimony, standing pat does not exist. As innuendo alone acts on rates. In both directions. Which the buck follows obediently.
Until the FED loses control of the buck as well. This is where we are at the moment.
The FED was first to unleash a tsunami of free money on the world. The withdrawal of that flow via the demise of QE3 was felt to be sure. The deflation of China as evidenced by the rout in commodities which followed is proof. Of the beginning of the end.
In response to that withdrawal which was announced under the guise of an improving US economy, the global economies took a defensive tack. The majors conjured up their own printing operations which engendered bigger trade imbalances, which of course led to the current forex war, the hallmark of which is the quest to debase one’s currency and in so doing, gain a trade advantage.
Any control of the Dollar is about to be snatched back from the FED. By a sequence of events set in motion by the FED itself.
As the effect of the global tidal wave of free money. Which arose out of necessity when the FED tapered QE into silence. Heads now for these shores.
Lifting the buck aloft. Accepting the deflation (which I prefer to call “negative inflation” at this juncture) without raising an official interest-rate finger. Because that m.o. has been rendered obsolete! Or if you prefer, just accept that any FED moves would be tantamount to shovelin’ schmitt against the tide [of printed money].
Please take a look at commodities if you need confirmation. Crude is leading the way lower.
All this relegates the FOMC to a new role as observers. Because they will be powerless to do anything much but watch. As the fruits of their toxic labor come home to roost.
QE1, 2 and 3 ran from late 2008 thru 2014.
During that period, the buck was under pressure, bouncing around. And intermittently bottoming vs. the Euro around the 1.50 level. It wasn’t until mid-2014 that the Euro had its last hurrah at 1.40. And then the buck finally got solid legs and has been rallying steadily from May of last year. Pretty much 1.40 to 1.13.
To the printer, then, goes the weak currency. And as we saw with the ECB, this is clearly by design.
As mentioned already, let’s dispense with the pretense of a solid US recovery. That’s hogwash, particularly the baloney about the tightening of the labor market. Housing’s punk state is self-evident and the slippage in consumer confidence, unnerving.
The FED is in a corner. They cannot raise rates. But because of the backlash comin’ at us now, the buck continues on a tear higher. They cannot control it.
So our economy will be impacted negatively not by official interest rates; the multinationals also come to mind for the stock pickers. Because we already know that the entire interest-rate, fiscal position, underlying economic metrics relationship has been decommissioned. By the tidal wave of printed money. That has us comin’ and goin’ at the moment.
With the present “beneficiary” the US Dollar.
We started it. We flooded it. We yanked it back. It’s their turn now.
Bend over, Rover. Any questions?
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