Why Powell Might NOT Cut Rates

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The market’s been bouncing around lately, anxiously waiting to see it the Fed cuts interest rates next week. All indications now suggest that it will. The question is by how much?

Minutes from June’s Federal Open Market Committee (FOMC) meeting that were released earlier this month indicated support for a rate cut. Certain committee officials noted that as long as uncertainty still weighed on its outlook, they would be willing to cut rates.

And during his much-awaited biannual testimony before the House Financial Services Committee, Federal Reserve Chairman Jerome Powell hinted — strongly — that a rate cut was around the corner.

Powell told the committee, “It appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.”

But the subsequent release of better-than-expected June employment figures complicated the matter of rate cut size and timing.

They raised the possibility that those positive jobs numbers would keep the Fed from cutting rates. After all, it doesn’t make a lot of sense to cut interest rates when the job market is so hot and unemployment is at 50-year lows.

But despite that concern, markets are still placing the odds of a rate cut of 25 basis points at 100%, with lower expectations for a 50 basis point cut.

This means a rate cut is already “baked into the cake.” However, the risk is that if Jerome Powell and the FOMC don’t cut rates next week, it could cause a sharp sell-off.

We’ll have our answer next week. But despite the overwhelming market expectations for a rate cut, I think there’s a chance the Fed won’t cut rates yet. That’s because Powell may still want to signal the Fed’s ability to act independently from White House pressure.

I realize that puts me in the extreme minority. But that’s OK, it certainly isn’t the first time.

But there’s something else going on right now that could trip up markets.

Earnings season is underway. Over the next few weeks, all of the S&P 500 companies will be rolling out their earnings figures. And more than a quarter of them will report earnings this week.

Firms from Google’s parent company, Alphabet, to Amazon, McDonald’s and Boeing are among the more than 130 companies that are reporting.

Even with a rate cut, poor corporate earnings could spell trouble for stocks. The trade war would be partly responsible. Certainly, there remains no resolution on the U.S.-China trade war front. And the trade war combined with slowing growth could amplify the effects of weak earnings.

As one article reports, “Stocks could struggle if the earnings message from corporate America focuses on the murky outlook for the economy and negative impacts from the trade wars.”

Earnings so far have been positive, but that can be misleading. That’s because second-quarter earnings expectations were kept low so that corporations could easily beat them.

Their actual earnings may not be underwhelming. But if they beat expectations, that’s all that counts.

And as I learned on Wall Street, corporations often talk down their earnings estimates in order to set a low bar. That way they can easily beat the forecast, which produces a jump in the stock price.

As Ed Keon, chief investment strategist at QMA explains:

No matter what the economic circumstances are, no matter what the backdrop is, there’s this dynamic that companies like to lowball and analysts like to give them headroom. The fact that numbers are coming in better than expected — it’s been the case for decades now.

Of the 114 companies that provided second-quarter guidance as of last week, 77% released negative forecasts, according to FactSet.

But it’s still early and there’s a long way to go.

Most industrial companies haven’t reported earnings yet. And they could reveal extensive damage from the trade war. As CFRA investment strategist Lindsey Bell says:

As we get more industrials in the next couple of weeks, I think that will create more volatility and drive the market lower in the near term… Chemicals and metals are two areas where I expect pressure.

We’ll see. But if markets do stumble, you can expect the Fed will be ready to cut rates at its meeting in September. That means more “dark money” will be coming to support markets, even if the Fed doesn’t cut rates next week.

And that’ll keep the bull market going for a while longer. One day the music will end. The imbalances in the system are just too great.

But we’re not at that point yet, and you can expect markets to rise on additional dark money injections.

Enjoy it while you can.

Below, I show you one major factor that will continue to support stocks this year. It doesn’t have to do with the trade war or earnings. What is it? Read on.

Regards,

Nomi Prins
for The Daily Reckoning

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Jerome Powell Caves

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Jerome Powell chummed the seawater this morning. And the voracious sharks rose to the bait… 

In written testimony to Congress, Mr. Powell informed us that:

Crosscurrents have reemerged. Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since [the Fed meeting in June], based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook… Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy.

What is more… he re-babbled his oath that the Federal Reserve would “act as appropriate to sustain the expansion.” 

Translated into good hard English: Expect a rate cut later this month.

Affirms Bloomberg Federal Reserve-ologist Steve Matthews: 

“Powell didn’t say so explicitly, but it’s hard to read this other than he thinks a cut in July would be appropriate.”

Powell’s dispatch, adds Peter Boockvar of Bleakley Advisory Group…

“…fully endorsed the July rate cut and did absolutely nothing to pull the markets back from that expectation.” 

The stock market was up and away on the news…

The S&P Tops 3,000 For The First Time In History 

For the first occasion in its 62 years… the S&P poked its head above the 3,000 mark this morning.

The Nasdaq registered a fresh record of its own. And the Dow Jones bounded nearly 200 points.

But the opening frenzy squandered much of the day’s energy… and the averages gradually lost their steam.

The Dow Jones ended the day up 75 points, at 26,859. 

After catching its first glimpse of 3,000, the S&P dipped back down to 2,992. The Nasdaq, meantime, closed the day with a 61- point gain. 

And so it goes…

100% Chance Of A July Rate Cut

Federal funds futures — incidentally — now give 100% odds of a rate cut later this month.

But what about the rest of the year… and next year? To what inky depths will the Federal Reserve lower rates?

Perhaps even lower than markets expect — if you take history as your teacher.

Markets presently expect Mr. Powell and his goons to cut rates 75 basis points by January.

Seventy-five basis points imply three rate cuts (a typical rate cut — or hike — is 25 basis points).

Three rate cuts by year’s end are plenty heady.

But according to Michael Lebowitz of Real Investment Advice, history argues even stronger drink is in prospect…

Markets Underestimate How Far Rates Could Sink

If the Federal Reserve undertakes a hike cycle, he maintains, it often elevates rates higher than markets project.

And when the Federal Reserve begins cutting rates… it hatchets them even lower than markets expect.

Lebowitz:

Looking at the 2004–06 rate hike cycle… the market consistently underestimated the pace of fed funds rate increases…

During the 2007–09 rate cut cycle, the market consistently thought fed funds rates would be higher than what truly prevailed…

The market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully.

Lebowitz says markets have underestimated rate cut intensity for the previous three cycles.

And Mr. Powell currently has his hatchet out.

In conclusion:

If the Fed initiates rate cuts and if the data… prove prescient, then current estimates for a fed funds rate of 1.50 –1.75% in the spring of 2020 may be well above what we ultimately see. 

And here Lebowitz seizes us by the shoulders… and gives us a good hard shaking:

Taking it a step further, it is not far-fetched to think that that fed funds rate could be back at the zero-bound or even negative at some point sooner than anyone can fathom today.

Who could? Fathom it, that is.

Just last year the monetary authorities gloated about “globally synchronized growth” and their march back to “normalcy.” 

Now they are preparing to about-face… and go scurrying back to zero? 

Who can take these gentlemen and ladies seriously?

The Fed Can Never Normalize Interest Rates

Here is our guess: Once they turn around, they will never come back. 

The Federal Reserve cannot return to normal. 

Returning to normal would knock the economy flat. And the stock market would come down in a thundering heap.

Only low interest rates keep it all vertical.

But as we have noted repeatedly… watch out for the next rate cut.

The past three recessions each commenced within three months of the first rate cut that ended a hiking cycle.

We find no reason to believe “this time will be different.”

The next rate cut — likely this month — starts the clock ticking.

We could be wrong of course. 

The inscrutable gods keep their own schedule. Who knows how long the show might run?

Out of Ammunition

But come the inevitable recession…

The Federal Reserve will have very little ammunition to hurl against it.

And the closer it gets to zero, the less ammunition it will hold.

History says it requires interest rates of at least 4% to wage a successful battle.

Rates are presently between 2.25% and 2.50%.

They are about to sink lower. Perhaps drastically lower. 

That is, the Federal Reserve is badly outgunned as it presently stands.

If the economy somehow pegs along until rates are zero — or near zero — the Federal Reserve would be on its knees… defenseless.

It will have another desperate go at quantitative easing. But multiple rounds did little (nothing) to raise the economy last time.

Why would it work next time?

The Next Crackpot Cure

That is why we expect the next anti-recession cure — disaster, that is — will not be monetary.

It will be fiscal.

The cries will go out…

“QE for Wall Street did nothing for the economy. The time for QE for Main Street has come.” 

The authorities will take to their helicopters, hover over Main… and begin shoveling money out the side.

The throngs below will haul it all in. They will proceed to go spreeing through the stores. The resulting delirium will give the economy a wild jolt.

That is the theory… as far as it runs.

It in part explains the loudening shouts for Modern Monetary Theory (MMT).  

Its drummers claim it can invigorate the wilting American economy.

They further claim it can fund ambitious social programs — all without raids upon the taxpayer.

And if interest rates are shackled down, without blasting the deficit.

The printing press will supply the money.

But as we have argued prior, MMT is the eternal quest for the free lunch… water into wine… something for nothing.

And that world has no existence.

MMT would likely yield a gorgeous inflation. But the economic growth it promises… would be a promise broken.

It will join the broken promise of monetary policy…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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A Tour of the Future

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Sharp, bracing winds have scattered the fog. The horizon is now visible… and the future drifts into focus.

Yes, we have the future in sight.

Today we report the way ahead.

We begin where we stand — upon creaking and groaning floorboards…

Recessionary Warnings in all Directions

Manufacturing surveys indicate global manufacturing contracted in May… for an unprecedented 13th-consecutive month.

The Manufacturing PMI (Purchasing Managers’ Index) surveys indicate manufacturing crawls at its slowest rate since September 2009.

United States factory orders expanded merely 1.0% in May — the lowest rate since President Trump took the throne.

The Cass Freight Index — a broad measure of domestic shipping activity and a plausible thermometer of economic health — has dropped 3.2% since last April.

Meantime, the bond market flashes warnings of a lean season ahead.

Ten-year Treasury yields have dropped to their lowest levels in two years, to 2.12%.

And the yield curve has inverted. An inverted yield curve nearly always precedes recession.

Thus we stand upon our precarious perch, wary of the shifting, sandy foundations beneath us.

But it is the future we have in mind today…

Morgan Stanley: 60% Chance of Recession Within One Year

The professional optimists of the Federal Reserve’s Atlanta branch office expect Q2 GDP to ring in at a slender 1.3%.

J.P. Morgan has lowered its own sights from 2.25% to 1%.

It also projects 10-year Treasury yields will sink to 1.75% by year’s end… and 1.65% by next March.

JP Morgan also — incidentally — places the odds of recession in the second half of this year at 40%.

It placed those same odds at 25% one month prior.

Morgan Stanley has also revised its Q2 GDP forecast from 1.0%… to a pale and sickly 0.6%.

It further gives a 60% likelihood of recession within the next year — its highest percentage since the financial crisis.

Of course, the Federal Reserve looms large in our vision…

Rate Cuts A2re Coming

The current rate hike cycle is ended. The Federal Reserve will next slash interest rates.

Its Federal Open Market Committee gathers in two weeks’ time.

As Craig Hemke of Sprott Money News notes, two options rise before the august ladies and gentlemen of the committee.

Neither is desirable:

1. Admit defeat and immediately cut the fed funds rate by up to 50 basis points.

2. Stall. And if they do this, bonds will rally even higher as the bond market will anticipate an even more dramatic global economic collapse.

The market votes heavily for Option 1.

Federal funds futures currently give nearly 70% odds of at least one rate cut by July.

By September these odds rise to over 90%, and by next January… to over 98%.

Some crystal gazers even hazard three rate cuts by this year’s end alone.

The Trigger for Recession

But as we have noted repeatedly… the next rate cut is a phony cure.

It is fool’s gold, a snare, a desert mirage.

The past three recessions ensued within 90 days of the first rate cut that ended a hiking cycle.

Affirms Zero Hedge:

While many analysts will caution that it is the Fed’s rate hikes that ultimately catalyze the next recession… it may come as a surprise to many that the last three recessions all took place [within] three months of the first rate cut after a hiking cycle!

We have every reason to expect the trend continues uninterrupted.

We further allow the possibility that the economy has already slipped into recession.

Recessions are often only identified several months after they commence — or longer.

Early next year, the bean counters may well point to Q2 2019.

Regardless, the recessionary straws are swaying in the stiffening breeze. Even Jerome Powell spots them.

“It’s Time to Rethink Long-run Strategies”

Mr. Powell realizes the standard rate cuts will fizzle woefully… like July Fourth sparklers that fail to spark.

So he will be on hand with more potent pyrotechnics.

From comments this week:

It’s time to rethink long-run strategies… Perhaps it is time to retire the term “unconventional” when referring to tools that were used in the crisis. We know that tools like these are likely to be needed in some form in the future… The next time policy rates hit the lower bound and there will be a next time it will not be a surprise.

Quantitative easing. Zero interest rates. Negative interest rates.

These and more tricks he doubtless has in mind.

And did you catch this bit?

“Perhaps it is time to retire the term “unconventional” when referring to tools that were used in the crisis.”

Just so.

Central banks have inflicted these “unconventional” tools upon the world’s citizens for 10 years — to varying degrees.

But if these gaudy and flashy devices met their advertising… why is the economy plunging into recession at all?

It is true, they have lit up the stock exchanges. But they fell as duds upon Main Street.

Why should they dazzle the crowd now?

They worked one primary effect:

To drill the world trillions of dollars deeper into debt.

Global debt has doubled post-financial crisis… as has the United States national debt.

Yet we return to the future…

Prepare for the Cannons of Fiscal “Stimulus”

We observe that the Federal Reserve’s punchless old fireworks have failed.

That is when the national authorities will haul out the cannons…

They will load them full of Modern Monetary Theory (MMT) — or “QE for the people.”

Rolling barrages of fiscal “stimulus” they will send raining down onto Main Street.

If a Democratic commander in chief is barking the orders at the time, he may load a Green New Deal into the breeches.

Free college tuition… universal Medicare… jobs for all… a $15 minimum wage.

All these and more it will promise — and save the world into the bargain.

The False Miracle of Debt

Like most crank ideas, these fevered schemes will fail in grand and spectacular style.

The false miracle of debt is their common delusion.

All debt-based consumption steals from the future to gratify the present. It is tomorrow’s consumption pulled forward.

It depletes the capital stock… and leaves the future empty.

It signs a perpetual check against an overdrawn future.

Mark Jeftovic of the Guerrilla Capitalism blog on MMT, which can extend to a Green New Deal:

Think of an MMT crisis as an economic black hole sucking all value from further and further future generations into a gravitational vortex of the present moment, where all value collapses in on itself and disappears forever.

Thus we conclude our tour of the horizon.

Mercifully, we can see no farther…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post A Tour of the Future appeared first on Daily Reckoning.

Has Recession Already Started?

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“Sit down before fact like a little child,” Thomas Huxley instructed, and “follow humbly wherever and to whatever abyss Nature leads…”

Today we sit down before facts, childlike… and follow humbly wherever and to whatever abyss they lead.

But what if the facts lead straight to the abyss of recession?

Facts 1: April orders for core nondefense capital goods slipped 0.9%.

Facts 2: April orders for durable goods — items expected to endure three years or more — sank 2.1%. Durable goods shipments overall dropped 1.6%… the most since December 2015.

Facts 3: April orders for transportation equipment plunged 5.9%.

Facts 4: April retail sales slipped 0.2%.

Facts 5: The “yield curve” has inverted good and hard — a nearly perfect omen of recession.

Has Recession Already Arrived?

Stack facts 1–5 one atop the other. What can we conclude?

“U.S. recession probably started in the current quarter.”

This is the considered judgment of A. Gary Shilling. Mr. Shilling is a noted economist and financial analyst.

And he gazes into a crystal ball less murky than most.

Wikipedia:

In the spring of 1969, he was one of only a few analysts who correctly envisioned the recession at year’s end and was almost a lone voice in 1973… the first significant recession since the Great Depression.

But is not the economy still expanding?

Q1 GDP rang in at a hale and hearty 3.2% — after all.

But peer behind the numbers…

Much Less than Meets the Eye

Much of the jauntiness was owing to transitory factors such as inventory accumulation.

Firms squirreled away acorns to jump out ahead of looming tariffs, giving Q1 GDP a good jolt.

But that jolt has come. And that jolt has gone.

Meantime, Q2 GDP figures will come rising from the bureaucratic depths tomorrow morning.

What can you expect from them?

A severe letting down, it appears…

Q2 GDP Estimates Revised Downward

Morgan Stanley has lowered its Q2 GDP forecast from 1.0%… to a sickly 0.6%.

J.P. Morgan has lowered its own sights from 2.25% to 1%.

Meantime, the professional optimists of the Federal Reserve’s Atlanta command ring in at a slender 1.4%.

Miles and miles — all of them — from the first quarter’s 3.2%.

Might these experts botch the actual figure?

They may at that… and it would not be the first instance.

But the weight of evidence here assembled loads the scales in the other direction.

Besides, recessions first appear in the rearview mirror. They are only identified several months to one year post factum… if not longer.

Perhaps the economy has already started going backward, as Mr. A. Gary Shilling suggests.

Or perhaps he has spotted a phantom menace, a shadow, a false bugaboo.

What does the “yield curve” have to say?

The Message of the Yield Curve

The yield curve is simply the difference between short- and long-term interest rates.

Long-term rates normally run higher than short-term rates. This happy condition reflects the structure of time in a healthy market.

The 10-year yield, for example, should run substantially higher than the 3-month yield.

The reason is close by…

The 10-year Treasury yield rises when markets anticipate higher growth — and higher inflation.

Inflation eats away at money tied up in bonds… as a moth eats away at a cardigan.

Bond investors therefore demand greater compensation to hold a 10-year Treasury over a 3-month Treasury.

And the further out in the future, the greater the uncertainty. Thus the greater compensation investors demand for taking the long view.

Compensated, that is, for laying off the sparrow at hand… in exchange for the promise of two in the distant bush.

Time Itself Inverts

But when the 3-month yield and the 10-year yield begin to converge, the yield curve flattens… and time compresses.

When the 10-year yield falls beneath the 3-month yield, the yield curve is said to invert. And in this sense time itself inverts.

The signs that point to the future lead to the past. And vice versa.

In the careening confusion, future and past run right past one another… and end up switching places.

Thus, an inverted yield curve wrecks the market structure of time.

It rewards pursuit of the bird at hand greater than two in the future.

That is, the short-term bondholder is compensated more than the long-term bondholder.

That is, the short-term bondholder is paid more to sacrifice less… and the long-term bondholder paid less to sacrifice more.

That is, something is dreadfully off.

“A Nearly Perfect Omen of Lean Days Ahead”

An inverted yield curve is a nearly perfect omen of lean days ahead. It suggests an economic winter is coming… when investors expect little growth.

Explains Campbell Harvey, partner and senior adviser at Research Affiliates:

When the yield curve inverts, it’s not the time to borrow money to take a vacation to Orlando. It is the time to save, to build a cushion.

An inverted yield curve has accurately forecast all nine U.S. recessions since 1955.

Only once did it yell wolf — in the mid-1960s.

It has also foretold every major stock market calamity for the past 40 years.

The yield curve last inverted in 2007. Prior to 2007, the yield curve last inverted in 1998.

Violent shakings followed each inversion.

History reveals the woeful effects of an inverted yield curve do not manifest for an average 18 months.

And now, in 2019… the doomy portent drifts once again into view.

The Bond Market’s Strongest Signal Since the Financial Crisis

The 3-month and 10-year yield curve inverted in March. It has since straddled the zero line, leaning with the daily headlines.

But this week the inversion has gone steeply negative.

We are informed — reliably — that the yield curve has presently inverted to its deepest point since the financial crisis.

Why is the 3-month versus the 10-year yield curve so all-fired important?

Because that is the section of the yield curve the Federal Reserve tracks closest. It believes this portion gives the truest reading of economic health.

Others give the 10-year versus the 2-year curve a heavier weighting.

But it is the Federal Reserve that sets policy… not others.

Federal fund futures presently offer 86% odds that Mr. Powell will lower interest rates by December… and 60% odds by September.

If recession is not currently underway, we are confident the Federal Reserve’s next rate cut will start the countdown watch.

Specifically:

Come the next rate cut, recession will be three months off — or less.

Why do we crawl so far out upon this tree limb?

President Trump Should Demand Jerome Powell Not Raise Interest Rates

The next rate cut will be the first after a hiking cycle (which commenced in December 2015).

And the past three recessions each followed within 90 days of the first rate cut that ended a hike cycle.

Assume for now the pattern holds.

Assume further the Federal Reserve lowers interest rates later this year.

Add 90 days.

Thus the economy may drop into recession by early next year.

Allow several months for the bean counters at Washington to formally identify and announce it.

You may have just lobbed recession onto the unwanting lap of President Donald John Trump… in time for the furious 2020 election season.

Could the timing be worse for the presidential incumbent?

Mr. Trump has previously attempted to blackjack Jerome Powell into lowering rates.

But if our analysis holds together…

The president should fall upon both knees… and beg Mr. Powell to keep rates right where they are…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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EXPOSED: The Fed’s Deepest Secret

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The announcement came issuing at 2 p.m. EST.

As roundly expected… Jerome Powell and his fellows sat idly upon their hands.

The fed funds rate remains chained in place, at 2.50%.

Mr. Powell, by way of explanation:

We think our policy stance is appropriate at the moment and we don’t see a strong case for moving in either direction. We say in our statement of longer-run goals and monetary policy strategy that the Committee would be concerned if inflation were running persistently above or below 2%.

The good chairman went on to dismiss last month’s weak inflation numbers as “transient.”

But is this the picture of “transience”?

Chart

Observe the trendline.

Where’s the (Official) Inflation?

Nearly 10 years on, the Federal Reserve pursues a grail agonizingly beyond its grasp — 2% inflation, sustained.

The latest data reveal March inflation increased only 1.6% year over year. January gave a reading of 1.8%.

Thus the Fed’s 2% target slips further beyond its outstretched fingers.

What — if any — credibility remains?

We can only cough sadly behind our hands, sink into our chair and look away in pity… as from a stage magician whose abracadabra has failed to conjure the rabbit.

So the time has come to expose the fraud sweating and writhing upon the stage… and reveal its deepest secret.

What is it?

To the answer we turn shortly. But first to the magic show on a parallel stage…

The Market Wanted a Rate Cut

The Dow Jones scraped along in positive numbers until word came down shortly after 2.

Upon which point it sank deeper and deeper into red, closing the day down 163 points.

Both S&P and Nasdaq followed nearly identical tracks.

The S&P ended the day 22 points lower; the Nasdaq 46.

Why the long faces on Wall Street?

The audience demanded a trick — a rate cut. And Mr. Powell failed to deliver.

Peter Boockvar, CIO of Bleakley Advisory Group:

“The market was pricing in this rate cut. They want a rate cut and this was basically Powell saying, ‘Sorry, but we’re not.’”

Not this time at least.

But to resume our exposé of the Federal Reserve… and its deepest secret…

The Federal Reserve Cannot Even Define Money

We begin with a premise:

The Federal Reserve can no longer define money. That is correct. It cannot even define money.

Imagine a butcher who cannot cut you a pound. Imagine a map maker who cannot measure a mile.

Now you have the flavor of it.

Under the Coinage Act of 1792, a dollar equaled one Spanish milled dollar — containing “371 grains and 4/16th parts of a grain of pure, or 416 grains of standard silver.”

Under the classic gold standard a dollar was defined as 1/20th of one ounce of gold. It was later defined as 1/35th of one ounce of gold.

But once old Nixon scissored the dollar’s final golden tether… the dollar defied all measurement.

It was as if 2.54 centimeters no longer defined an inch but a mile. Twelve inches no longer defined a foot but an inch. Three feet no longer defined a yard but a mile.

Perhaps you define a dollar as 100 cents. Well then, what is a cent? 1/100th of a dollar. But what again is a dollar?

And so you embark upon an infinite chasing of your tail.

We must conclude that today’s money is largely abstraction — wispy as gossamer, slippery as eels, elusive as quicksilver.

It is measured by a warring arrangement of alternate “money supplies” — none of which meet full requirements:

Unit of account, medium of exchange… store of value.

Alan Greenspan Comes Clean

Thus the Federal Reserve steers by the swaying and erratic lights of M0, M1, M2, MZM, etc.

Here we have money, near money, money at second and third remove, money somewhere in the ghostly ether.

And so the monetary authority cannot heave forth a working definition of money… or its true supply.

But do not rely upon our slanted word.

This we have on the authority of the maestro himself — Alan Greenspan — who confessed nearly 20 years previous that:

The problem is that we cannot extract from our statistical database what is true money conceptually…

One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing… 

While of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition. 

Two decades, a great financial crisis and multiple rounds of QE later, the proposition has grown more dubious yet.

What and where is money? Where is inflation?

As notes Jeff Snider of Alhambra Investments, wryly:

“If you can’t ‘locate’ money, you can’t locate inflation.”

A Basic Definition of Money

We would argue that it is located in the asset classes — equities, real estate, etc.

But let us cleave to the simplest definition of money as defined by the late “Austrian” school economist Murray Rothbard:

The thing that all other goods and services are traded for, the final payment for such goods and services on the market.

True money is the “final” payment, that is. Only this money satisfies all obligations, retires all debts.

Economists of the Austrian School crafted a metric they labeled the “true money supply” (TMS) in the 1970s and ’80s.

Existing measures of money supply gave distorted readings, they claimed.

The true money supply consists of cash, demand deposits (i.e., checking accounts) at banks, savings… and government deposits at the Federal Reserve.

That is, it consists of money immediately available for transaction.

The TMS broad money supply is therefore more restrictive than the Federal Reserve’s broadly defined M2, for example.

March 2018 to March 2019, the official M2 money supply expanded 3.8%.

But TMS-2 year-over-year growth speaks a different tale…

Year-over-year TMS-2 money supply expanded a mere 2.2% in March, says analyst Michael Pollaro — its slowest pace in 12 years.

And preliminary data indicate year-over-year TMS-2 expansion has slipped to 1.7% in April.

That is, by the narrow TMS-2 reading, money supply is expanding at a far lesser clip than official M2.

Might this vast discrepancy explain the soft inflation data as officially presented?

An Arresting Conclusion

We cannot say for certain — we are not a credentialed member of the professional economics guild.

Thus we lack all official standing.

Might the theory wobble, might it stagger before an onslaught of evidence?

It may very well.

Then you can add it to the existing list of quack theories.

But the fact remains:

Nearly 10 years on, the Federal Reserve cannot work a sustained 2% inflation.

After long, hard pummeling of our cerebral centers, thus do we arrive at this arresting conclusion, the Federal Reserve’s deepest secret:

The Federal Reserve exerts little actual control upon the monetary system.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post EXPOSED: The Fed’s Deepest Secret appeared first on Daily Reckoning.

Expect the Buyback Wave to Continue This Year

This post Expect the Buyback Wave to Continue This Year appeared first on Daily Reckoning.

A crucial theme from last year is continuing into this year — stock buybacks. Last year was a banner year for companies buying back their own shares. A month into 2019, it appears that Wall Street is set to continue that trend.

Last year, U.S. companies announced a whopping $1.1 trillion worth of buyback plans. Armed with extra cash from favorable corporate tax policy enacted in 2017, they enthusiastically bought back their own shares.

But as of mid-December, only about $800 billion of those buybacks had actually occurred. That means there could be another $300 billion of the total 2018 target still waiting to hit the market.

In fact, Wall Street is already gearing up for another banner buyback year. In a recent report, J.P. Morgan strategist Dubravko Lakos-Bujas wrote, “It’s expected that S&P 500 companies will execute some $800 billion in buybacks… in 2019.”

The Wall Street strategist also explained that the quality of 2018 buybacks were high. He revealed that companies were using their cash, rather than borrowed money, to fund buybacks. Using cash toward buybacks is expensive less than using debt.

But why did the wave of buybacks slow down late last year?

The first reason is that companies involved had already purchased stock at a very rapid rate through last September. That was one major reason we saw the market peak around that time, and in fact, hit new records.

The second was that despite trade war fears and uncertainty, companies felt confident enough to go ahead with their buybacks initially. That’s why we saw market players largely shrug off warning signs through the first three quarters of 2018.

But sentiment shifted dramatically during the last quarter of the year, culminating in essentially a bear market by late December. And more reports around the world began to point to slowing economic growth ahead.

A key factor cited for this slowdown was the impact of prolonged trade wars, which could curb real economic activity and create more uncertainty. In turn, growing volatility would keep businesses from planning expansions, or using the cash originally set aside for buybacks.

A third reason for the drop off in buybacks late last year was a record amount of public corporate and consumer debt that had to be repaid or at least serviced regularly. This overhang of debt was weighing on growth expectations. That debt load would become even more expensive if the Fed kept up with its forecasted rate hike activity in December and throughout 2019.

Some analysts even warned that the Fed might go ahead with another four rate hikes this year. That triggered fears on Wall Street that the central bank stimulus game could truly be over.

The reason for the concern is simple: The higher the interest rates, the more expensive it is to borrow and repay existing debt. For more highly leveraged corporations and emerging market countries, this would be an even greater threat. A higher dollar, resulting from more Fed tightening, could cause other currencies to depreciate against the dollar. That would make it harder to repay debt taken out in dollars.

Finally, there was heightened tension in the financial markets due to political uncertainty. With U.S. election results ensuring added battles between Congress (with Democrats taking the majority in the House of Representatives) and the White House, doubt set in over the functionality of the U.S. government going forward.

Those reservations were justified. The government shutdown that kicked off 2019 had a lot to do with shifts in the political balance in Washington.

Geopolitical tensions also rose at the end of 2018, including Brexit in the United Kingdom, street revolts in France, potential recession fears in Italy and growing unrest in South America.

All these factors combined ensured that markets were extremely volatile during the last quarter of 2018, and why it was the worst one for the markets since the Great Depression. It was not conducive to buybacks. Buybacks are supposed to raise the stock price. But strong market headwinds could have largely canceled their effects.

The prudent approach for companies facing such a negative environment was to wait out the problems until the new year.

But Jerome Powell subsequently gave into Wall Street and took a much more dovish position on both rate hikes and balance sheet reductions. That means the coast is clear again to resume the buybacks.

Back in December, some major players announced plans for 2019 buybacks. These include Boeing, which announced an $18 billion repurchase program. It also includes tech giant Facebook, which plans to buy back $9 billion of its own shares, in addition to an existing $15 billion share repurchase program started in 2017.

Also in on the buyback wave is Johnson & Johnson, which announced a $5 billion stock buyback. Others include Lowe’s and Pfizer, which both announced a $10 billion stock buyback program.

These plans are now much more likely to go forward.

Furthermore, many large corporations like Microsoft, Procter & Gamble, Home Depot and Walmart didn’t even announce buybacks in 2018.

They could well announce them for 2019. Companies that did announce big buybacks last year, like Apple, could also engage in more, adding a potential $100 billion share repurchases this year to match 2018.

Another indicator for a sizeable 2019 buyback wave is that stock prices are lower now than they were going into the fourth quarter of 2018. That means companies can buy back their shares at cheaper prices. They could buy at a discount, in other words, or at least what they hope will be a discount.

My old Wall Street firm, Goldman Sachs, has already forecast $940 billion worth of buybacks for 2019. They previously had predicted over a trillion dollars’ worth of buybacks for 2018. The number of buybacks for 2018 even exceeded their predictions.

By mid-January, of the S&P 500 companies that reported their fourth-quarter earnings, nearly 70% of them have exceeded Wall Street’s profit expectations. It’s a favorable environment for buybacks.

Yet, it may still take some time for companies to move forward with this year’s buybacks. That’s because we are still in the “black-out” period that the Securities and Exchange Commission (SEC) has created.

The period covers the time just before and after companies post earnings results. The sell-off in October coincided with the third quarter earnings season’s “blackout period.” The combination of negative environmental factors plus fewer buybacks drove markets even lower.

Now, once earnings season and the current blackout period is over, Wall Street will be unleashed to buy large blocks of stock for their major corporate clients.

If the Federal Reserve truly holds back on its former interest rate and quantitative tightening plans, as it seems likely to do, expect central bank stimulus to continue to fuel markets.

Of course, buybacks do not come without negative implications. That’s because companies are not using their cash for expansion or to pay workers more, which would generate more buying power in the overall economy. But in the short run at least, they tend to raise the stock price.

Even if Wall Street comes up against headwinds of volatility, slowing economic growth, political strife and trade wars, they can now expect the Fed and other central banks to have their backs.

Buybacks could become a very powerful force once again this year, and keep the ball rolling a while longer.

Regards,

Nomi Prins

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The Next Great Monetary Experiment

This post The Next Great Monetary Experiment appeared first on Daily Reckoning.

“Dow just broke 25,000. Tremendous news!”

Thus the president delivered a blast for the stock market yesterday… for the first time since October.

Yesterday’s 435-point surge was substantially due to Jerome Powell’s pledge to be “patient.”

Further, that he is prepared to take his hands off the balance sheet:

The committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program.

Mr. Powell has clearly broken.

Wall Street has him — as it had Janet Yellen, as it had Ben Bernanke, as it had Alan Greenspan before him.

“Bond king” Jeff Gundlach even believes yesterday’s reference to a “full range of tools” clears the way for more quantitative easing:

And if need be, the Fed will expand the balance sheet. QE (quantitative easing) is the “unnamed” other policy tool he referenced in case lowering the fed funds rate proves not to be enough to strengthen the economy/markets.

But today we announce another monetary experiment ranging far beyond quantitative easing…

It is an audacious plan presently gaining currency among Democratic politicos — but not exclusively among Democratic politicos.

It would furnish the wherewithal for a “Green New Deal,” universal health care, free college for all… and guaranteed employment.

You may think of it — if you wish — as QE for Main Street.

“[It] is coming,” warns analyst Kevin Muir. “Ignoring it would be foolish.”

The American people are losing trust in the present ways, argues Muir.

They see that QE, for example, has primarily enriched Wall Street. They in turn have scratched by on the leavings.

And they are eager for change:

The public has woken up to the fact that supply-side-trickle-down economics is not helping them anywhere near as much as promised.

You might think these sorts of tax-cutting pro-business policies are the best thing for our economy. So be it… But the tide is shifting away from this belief…

Society’s mood has changed and [these] concepts will continue to gain supporters.

But as you will see, Wall Street will likely line up behind it as well.

To what policy do we refer?

Modern Monetary Theory — MMT hereafter. 

MMT attained recent publicity when newly installed congresswoman from New York, Alexandria Ocasio-Cortez, caroled its virtues.

What is MMT precisely?

Below we do its picture in broad brushstrokes. Some of its details remain dim to us. They are also apparently dim to its boosters… we might note.

But to proceed in general outline…

Wikipedia defines MMT in this fashion:

A macroeconomic theory that describes the currency as a public monopoly and unemployment as the evidence that a currency monopolist is restricting the supply of the financial assets needed to pay taxes and satisfy savings desires.

Reduced to the language of the everyday, its meaning is this:

The government runs a monopoly on the currency. Citizens must pay taxes in the same currency. The currency therefore supplies its own demand.

Central to the theory is that government must first spend money into circulation before it can be taxed (the tax aspect will soon become apparent).

Furthermore, it enjoys a nearly unlimited capacity to print money.

MMT argues that government spending should therefore not be limited by the reach of the tax man.

That is, you needn’t crawl before the American people with hat in hand — gun in hand, actually.

You simply print the money.

If John is unemployed, if Jane cannot swing tuition, if Joe lacks health care… you simply print the money to fund the necessary programs.

Then you march it off for duty in the general economy, where it makes the shortages good.

MMT says unemployment, for example, is direct evidence that money is overtight.

Print enough and you have solved the crisis.

But didn’t the government print money like bedlamites after the financial crisis? How can money be tight?

Ah, but the trillions QE conjured went to the service of credit markets, where it braced the financial system.

It did not enter the Main Street economy. And that is why inflation never got to its legs.

With MMT the money goes straight to the Treasury.

It is then spent into public circulation, on a New Deal for example  — green, red, blue, purple or pink.

Or for free college… universal Medicare… jobs for all.

Here is your route to prosperity, they say, an economic El Dorado.

But perhaps it all brings you up short.

Does MMT not mean spiraling deficits, you ask? Who will pay for it?

But you ask the wrong questions, say the MMT theorists.

They — like Dick Cheney — will tell you deficits are largely irrelevant.

Do not forget, they remind you:

The government can simply print the money to cover its debts.

The United States government can never go broke. It can always print its way out.

Economist Stephanie Kelton advised Bernie Sanders during his 2016 fling at the White House.

She also captains the MMT cheer squad. From whom:

If you control your own currency and you have bills that are coming due, it means you can always afford to pay the bills on time. You can never go broke, you can never be forced into bankruptcy. You’re nothing like a household.

Just so.

Now comes your next objection:

This MMT sounds like a recipe for immense inflation, even hyperinflation.

You are spending all this money directly into the economy. It will drive consumer prices through the attic roof, you say. This is crackpot. A witch’s sabbath of inflation would surely result.

Yes, but here the MMT crowd meets you head on…

They agree with you.

They agree MMT could cause a general inflation, possibly even a hyperinflation.

In fact, inflation is the one limiting factor they recognize, the monkey wrench jamming the works.

But they have the solution on tap: taxation. 

Fill a tub. It runs over. You open the drain.

Under MMT the economy is the tub. Taxation is the drain.

Whenever inflation menaces, whenever the tub runs over, the economy is exceeding capacity.

The government then simply removes the excess dollars by taxing them out of the system.

And so inflation is licked.

Under the theory, in fact, stifling inflation is the primary purpose of taxation.

It is not to raise revenue. Remember the central role of the printing press under MMT.

But what about controlling inflation with higher interest rates?

Is not inflation the domain of the Federal Reserve?

No, says MMT — and this is why Wall Street will fall in behind it:

Interest rates must be pegged near zero for the entire business to function.

The Federal Reserve’s primary function is to keep them there.

From a New York magazine piece on MMT:

The primary way the government controls inflation now is through monetary policy: The Fed raises interest rates when it believes (correctly or otherwise) that inflation threatens a rise. But MMT thinkers tend to believe interest rates should be kept low and stable, regardless of inflation conditions… Without the interest rate lever, once MMT policymakers achieved their goal of an economy at full employment, the tool they’d have to use to control inflation is [taxation].

An economist named Warren Mosler is another grandee of the MMT movement.

Says he:

“I would make… zero interest rate policy permanent.”

Now can you see why Wall Street would embrace MMT with two arms?

But where is all this heading? Does it have a chance?

Tune in for Part II tomorrow.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Three Concerns Hanging Over the Davos Elite

This post Three Concerns Hanging Over the Davos Elite appeared first on Daily Reckoning.

This week, the global elite descended private jets to their version of winter ski-camp – the lifestyles of the rich and powerful version.  The World Economic Forum’s (WEF) five-day annual networking extravaganza kicked off in the upscale ski resort town of Davos, Switzerland.

Every year, the powers-that-be join the WEF, select a theme, uniting some 3000 participants ranging from public office holders to private company executives to the few organizations that truly do help fix the world that they mess up.  This year’s theme is “Globalization 4.0”, or the digital revolution. The idea being, the potential tech take-over of jobs, and what wealthier countries are doing to lesser developed ones in the process.

While the topic might be focused on the future, the present is just as troubling, if not more so, than the future.   Such is the disconnect between real people and corporations.  That’s what the estimated 600,000 Swiss Franc membership to be a part of the WEF constellation gets you as a CEO at the Davos table.

Government leaders like German Chancellor Angela Merkel, Brazil’s president, Jair Bolsonaro and Chinese Vice President, Wang Qishan are in attendance this week. Business leaders like Microsoft co-founder Bill Gates and JPMorgan Chase CEO, Jamie Dimon will also take part in the festivities.

Yet, even though the various leaders will likely promote their achievements, what’s lurking behind the pristine snowcapped Alps, is a dark foreboding of a less secure world. Nearly every major forecast from around the world is projecting an economic slowdown. As one Bloomberg article reports, “companies are the most bearish since 2016 as economic data falls short of expectations and political risks mount amid an international trade war, U.S. government shutdown and Brexit.”

The list of non-attendees includes U.S. President Donald Trump, UK Prime Minister Theresa May and French President, Emmanuel Macron. They are too busy dealing with complex political problems in their own government institutions and domestic home fronts to make the trek.

Below is a breakdown of the three flashpoints that the Davos crowd should be watching in 2019:

Economic Growth Will Slow

Signs of slowing global economic growth are increasing. We’re seeing that in both smaller emerging market countries and larger, more complex ones. Weaker-than-anticipated data from the U.S., China, Japan and Europe are stoking worries about the worldwide outlook for 2019.

Many mainstream outlets are beginning to understand the turmoil ahead. Goldman Sachs, my old firm, is predicting an economic slowdown in the U.S. And the International Monetary Fund (IMF) has revised downward its 2019 U.S. growth prediction to 2.5% from 2.7% from 2018. It believes that the U.S. will be negatively impacted by the economic slowdowns of American trade partners and that the 2020 slowdown could be even “sharper” as a result.

The IMF also points to pressure from ongoing trade tensions between the U.S. and China and growing dysfunction between the U.S. and other major trading partners, such as Europe.

Because the world’s economies have become increasingly interdependent, problems in one economy can have widespread consequences. We learned this once before: the collapse of U.S.-based investment bank, Lehman Brothers, triggered a greater international banking crisis in 2008. That sort of connectivity has only grown. The reality is that we may now face even greater threats than forecast so far, which could lead to another financial or credit crisis.

It is likely that China could be ground zero for a global economic slowdown. Recent data out of China indicates that much global GDP and trade activity that should normally be in the first quarter (Q1) of 2019 was pulled forward into Q4 2018 to “beat” the tariff increase.

It’s likely that the same phenomenon could happen in the U.S. If this trend does snowball, you should expect to see rapidly deteriorating economic numbers arriving in the months ahead.

Debt Burdens Will Worsen

No matter how you slice it, public, corporate and individual debt levels around the world are at historical extremes. Household debt figures from the New York Federal Reserve noted that U.S. household debt (which includes mortgage debt, auto debt and credit card debt) was hovering at around $13.5 trillion. That debt has risen for 17 straight quarters.

What is different this time is that current levels are higher than just before the 2008 financial crisis hit.

In addition, global debt reached $247 trillion in the first quarter of 2018. By mid-year, the global debt-to-GDP ratio had exceeded 318%. That means every dollar of growth cost more than three dollars of debt to produce.

After a decade of low interest rates, courtesy of the Fed and other central banks, the total value of non-financial global debt, both public and private, rose by 60% to hit a record high of $182 trillion.

In addition, the quality of that debt has continued to deteriorate. That sets the scene for a riskier environment. Over on Wall Street they are already disguising debt by stuffing smaller riskier, or “leveraged” loans into more complex securities. It’s the same disastrous formula that was applied in the 2008 subprime crisis.

Now, landmark institutions like Moody’s Investors Service and S&P Global are finally sounding the alarm on these leveraged loans and the Collateralized Loan Obligations (CLOs) that Wall Street is creating from them.

CLO issuance in the U.S. has risen by more than 60% since 2016. Unfortunately, it should come as no surprise that Wall Street is now proposing even looser standards on these risky securities. The idea is that the biggest banks on Wall Street can actively repackage risky leveraged loans into dodgy securities while the music is still playing.

If rates do rise, or economic growth deteriorates, so will these loans and the CLOs that contain them, potentially causing a new credit crisis this year. If the music stops, (or investors no longer want to buy the CLOs that Wall Street is selling) look out below.

Corporate Earnings Will Be Lower

With earnings season now underway, we can expect a lot of gaming of results in contrast to earlier reports and projections. What I learned from my time on Wall Street is that this is a standard dance that happens between financial analysts and corporations.

What you should know is that companies will always want to maximize share prices. There are several ways to do that. One way is for companies to buy their own shares, which we saw happen in record numbers recently. This process was aided by the savings from the Trump corporate tax cuts, as well as the artificial stimulus that was provided by the Fed through its easy money strategy.

Another way is to reduce earnings expectations, or fake out the markets. That way, even if earnings do fall, they look better than forecast, which gives shares a pop in response. However, that pop can be followed by a fall because of the lower earnings.

The third way is to simply do well as a business. In a slowing economic environment, however, that becomes harder to do. Plus, it’s even more difficult in today’s environment of geopolitical uncertainty, as a multitude of key elections take place around the world in the coming months.

These three concerns were central in conversation in Davos. Expect global markets to be alert to the comments coming from the Swiss mountain town. Severe dips and further volatility could be ahead if any gloomy rhetoric streams from the Davos gathering.

How Will the Fed React?

Ready to help, is the answer. This month, yet another top Federal Reserve official noted that economic growth could be slowing down. That would mean the Fed should, as Powell indicated, switch from its prior fixed plan of “gradually” raising interest rates to a more “ad-hoc approach.”

Indeed, Federal Reserve Bank of New York President John Williams, used Chairman Powell’s new buzz phrase, “data dependence,” to indicate that the Fed would be watching the economy more. While he didn’t say it explicitly, it has become largely clear that the markets are determining Fed policy.

Based on my own analysis, along with high-level meetings in DC, I see growing reasons to believe the Fed will back off its hawkish policy stance. As we continue to sound the alarm, there are now a myriad of reasons including trade wars, slowing global economic conditions and market volatility.

Traders are now assigning only a 15% chance of another rate hike by June. Just three months ago, those odds were 45%.

Watch for even more market volatility with upward movements coming from increasingly dovish statements released by the Fed and other central banks. Expect added downward outcomes from state of the global economy along with geo-political pressures.

Regards,

Nomi Prins

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Volatility Holds the Key to Markets in 2019

This post Volatility Holds the Key to Markets in 2019 appeared first on Daily Reckoning.

Over the last two weeks, after making good on the four-rate interest hike of 2018, Fed Chairman, Jerome Powell, became more dovish to start 2019.

His change in tone is worth considering because of his historical stance on reducing the amount of artificial stimulus coming from the Fed. Last week, after the required five-year holding period for Fed transcripts were up, we got a glimpse into Powell’s thoughts from 2013, before he was Chairman.

Powell tried to persuade then-Chairman, Ben Bernanke, to reduce the Fed’s stimulus, even though it would lead to greater near-term market volatility. That was when the third round of the Fed’s asset-buying program (QE3) was in full swing. The Fed was purchasing an estimated $85 billion per month mix of Treasuries and mortgage-backed securities.

To indicate that the Fed wouldn’t buy bonds forever, Bernanke floated the idea of slowing down its program, or “tapering,” at some non-defined future date.

Powell, on the other hand, believed the market needed a specific “road map” of the Fed’s intentions. He said that he wasn’t “concerned about a little bit of volatility” though he was “concerned that there may be more than that here.”

Indeed, once Bernanke publicly announced the possibility of the Fed’s bond-buying program slowing down, the market tanked, in a response that became known as a “taper tantrum.” As a result, Bernanke backed off the tapering idea.

Fear of more taper tantrums kept the Fed in check after that. The Fed ultimately waited until it had raised rates sufficiently, before starting to cut the size of its balance sheet. But now Powell is the Chairman. And it seems that he is much less comfortable with volatility than he was under Bernanke, as his most recent remarks indicate.

But it certainly wouldn’t be the first time a Fed chairman has modified his views when he was in control. Alan Greenspan, for example, was a staunch advocate of the gold standard when he was younger (and as presented in Foreign Affairs). But once he was Fed head, suddenly he thought a gold standard wasn’t such a hot idea after all. Go figure.

In the case of Jerome Powell, his new sensitivity to volatility means the Fed will be watching the markets for high volatility that causes sell-offs, even if also espousing their “data driven” mentality. And that he is prepared to act should that happen by backing off the Fed’s current forecast for reducing its balance sheet.

I’ve argued before that the Fed isn’t reducing its balance sheet as aggressively as it would have you believe. And I certainly expect it to dial back even more so in light of the recent volatility.

The reason is obvious.

The main catalyst for the bull market that surfaced over the past 10 years since the financial crisis in 2008 was stimulus that was fueled by the Fed and other leading central banks. This money acted as an artificial stimulant or “drug” to financial asset prices.

The world’s leading central banks have been following the Fed’s lead in withdrawing liquidity. And even though global liquidity really began drying up late last year to a minimal degree relative to its size, it should come as no surprise that markets have threw a tantrum.

Since early October, we’ve seen a lot of price volatility, with several hundred-point daily swings in the markets becoming the norm. Powell calmed the waters with his dovish comments on January 4 and the following week as well. But make no mistake, the waters are still choppy.

Many on Wall Street expect to see more volatility ahead and are forecasting that 2019 will be rocky for the stock market. But others on Wall Street are, in direct contrast, forecasting a continued bull market.

That’s the other driver of volatility — clashing opinions and wildly divergent market forecasts. We haven’t had much volatility in recent years because nearly everyone was on the same side of the bet. That’s all changed now.

To add to the market turmoil, the federal government shutdown has now officially entered its fourth week. It is now the longest shutdown on record. But the shutdown also has real economic ramifications outside of the DC beltway.

First, in a climate where the expansion of business activity is already slowing down, the shutdown is causing economists to further lower first-quarter GDP estimates. That puts a lid on expansion and hiring plans for both psychological and actual risk reasons.

More than 800,000 federal workers have missed paychecks, which means less money to pay bills and purchase goods and services that contribute to the American economy. But that’s not the only problem, although it might seem far more important, especially to those missing paychecks.

From an information standpoint, the state of the economy is tough to predict without data produced by agencies like the Department of Commerce. For instance, farmers, already hurting from trade wars, won’t be able to get key data on figures like monthly international shipments to plan crop schedules.

Then there’s the Federal Reserve itself. Whether you think it should or not be setting interest rates at all, the Fed determines interest rates while considering factors such as market volatility, slowing economic figures and trade wars. The best way to do that is to access real data. Now, business conditions will be hard to gauge accurately if reports aren’t available due to the shutdown.

That means the shutdown will stoke volatility in the markets until an agreement is reached. And when that will be is anybody’s guess right now. No real progress has been made and there doesn’t appear to be an end in sight.

But this week, the markets will be getting new information to digest. The release of fourth-quarter earnings reports will begin with big banks. These will provide more insight into how companies performed during the year-end volatility in 2018.

The corporate earnings outlook on Wall Street is fairly negative. Companies have been managing expectations downward. Apple, for instance, chopped its forecasted revenue figures last month, citing the slowdown in China’s economic growth as a reason for less iPhone sales. Apple stock lost about 10% on the day of the announcement, taking the overall market down with it.

Analysts are now estimating fourth quarter profit growth of 14.5% for the S&P 500 companies. That’s down from the 20.1% they forecast at the start of the quarter. But that could actually be a good thing for share prices.

The lower the bar, the greater the possibility it can be exceeded. There’s more upside potential in that case, in other words. That means if earnings begin to outperform prior forecasts next week, it could very well lift the markets. This tension of negative and positives factors will foster a see-saw of a quarter in the markets mixed with volatility, so being aware and nimble will be the best strategy.

But the volatility could present a great trading opportunity. Wall Street knows that it doesn’t matter if information is positive or negative — there are still ways to profit from the right information.

Something called the Cboe Volatility Index (VIX) is widely considered a “fear gauge.” That’s because it’s supposed to reflect what swings in the S&P 500 index could be over the next month.

The VIX computes its levels based on outstanding options contracts which are supposed to indicate the price that investors, or speculators, are willing to pay for protection against their positions going bad.

Currently, the VIX should be higher than it is. It recently spiked, but then settled down much lower than what the real volatility of the S&P has been this past month.

Usually, options tend to over-price volatility. That’s because people buy options in order to place bets on the future, or to protect themselves from wild swings in share prices. The less certain they are, the more they are willing to pay for that protection.

Yet, right now, the cost of protection is cheap. That’s like your health insurance premium all of a sudden dropping just when you catch a major illness. It doesn’t quite make sense.

That means that while fourth-quarter earnings season reports are emerging, it’s a good time to take advantage of buying these cheap options. Buying them on certain companies can protect you against adverse swings in share prices due to earnings announcements. It’s a form of portfolio insurance. And again, it’s relatively cheap.

That’s one pivotal key to being a great investor — accessing information. Sure, the more insights and information you have, the more overwhelming it can seem. However, if you can stay focused, your portfolio will thank you.

Regards,

Nomi Prins
for The Daily Reckoning

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Jay Powell’s Gift to Markets

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Fed Chair Jay Powell did not deliver any early Christmas presents to the markets last month, but he did pop the cork on a bottle of Champagne as a belated New Year’s gift on Friday, Jan. 4.

With just a few words, Powell sent the most powerful signal from the Fed since March 2015. Investors who understand and properly interpret that signal stand to avoid losses and reap huge gains in the weeks ahead.

First, let’s focus on Powell’s comments. Then we’ll explain what they actually meant.

The Fed has taken a March rate hike off the table until further notice. At a forum in Atlanta two Fridays ago, Powell joined former Fed chairs Yellen and Bernanke to discuss monetary policy.

In the course of his remarks, Powell used the word “patient” to describe the Fed’s approach to the next interest rate hike. When Powell did this, he was reading from a script of prepared remarks in what was otherwise billed as a “roundtable discussion.” This is a sign that Powell was being extremely careful to get his words exactly right.

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke

Fed Chairman Jay Powell (left) joined former Fed chairs Janet Yellen and Ben Bernanke at a roundtable in Atlanta recently. Powell revived the word “patient,” which was last used by the Fed in December 2014. It’s a powerful signal of no rate hikes until further notice.

When Powell said the Fed would be “patient” in reference to the next rate hike, this was not just happy talk. The word “patient” is Fed code for “No rate hikes until we give you a clear signal.” This interpretation is backed up by the Fed’s past use of verbal cues to signal ease or tightening in lieu of actual rate hikes or cuts.

The word “patient” has a long history in the Fed’s vocabulary. Prior to March 2015, the Fed consistently used the word “patient” in their FOMC statements. This was a signal that there would not be a rate hike at the next FOMC meeting. Investors could do carry trades safely.

As long as the word “patient” was in the Fed’s statements, investors knew that there would be no rate hike without warning. It was like an “all clear” signal for leveraged carry trades and risk-on investments. Only when the word “patient” was removed was the Fed signaling that rate hikes were back on the table. In that event, investors were being given fair warning to unwind carry trades and move to risk-off positions.

In March 2015, Yellen removed the word “patient” from the statement. That was a signal that a rate hike could happen at any time and the market was on notice. If you had a carry trade on and were relying on no rate hike, then shame on you.

In fact, the first rate hike (the “liftoff”) did not happen until December 2015, but the market was on notice through the June and September 2015 FOMC meetings that it could happen. (The liftoff was originally planned for September 2015, but was postponed because of the U.S. market crash in August 2015. This crash was due to the shock 3% China currency devaluation on Aug. 10; U.S. stocks fell 11% in four weeks.)

Now, for the first time since 2015, the word “patient” is back in the Fed’s statements. This means no future Fed rate hikes without fair warning. This could change again based on new data and new statements, but a change is unlikely before March at the earliest. For now, the Fed is rescuing markets with a risk-on signal. That’s why the market rallied that Friday and has reversed December’s downward trend.

But we’re not out of the woods. Just because the Fed signaled they will not raise rates in March does not mean that all is well with markets. The U.S. stock market had already anticipated the Fed would not raise rates in March. The statement by Powell confirms that, but this verbal ease is already priced in. As usual, the markets will want some ice cream to go with the big piece of cake they just got from Powell.

On the one hand, if we’re at or near the start of a bear market it will take more than a Fed pause to offset that. On the other hand, there’s no reason for markets to crash based on the U.S. economy alone since the Fed may make more candy available by continuing to use the word “patient” in March. So we’re in wait-and-see mode.

Meanwhile, there’s an even bigger threat on the horizon — China. Unobserved by many analysts, the Chinese are reducing their money supply even faster than the Fed.

The Fed’s signal on rates says nothing about Fed reductions in the money supply under the quantitative tightening (QT) program. The U.S. money supply reductions are going ahead at $600 billion per year.

China is burning money even faster to prop up the yuan in the midst of a trade war with Trump. What does it mean when the world’s two largest economies, comprising 40% of global GDP, both hit the brakes on money supply?

Nothing good. Milton Friedman demonstrated that monetary policy operates with a lag of 12–18 months. These U.S. and Chinese monetary tightening policies started just over a year ago. The initial impact of what has already been done by the central banks is just being felt now.

This means that the U.S.-China tightening will continue to be felt over the next year regardless of what the Fed does in March. Stopping rate hikes now is like hitting the car brakes when you’re driving on a frozen lake. You’re going to slide a long time before the car comes to a halt. Let’s hope you don’t hit a soft spot before then or you’ll end up underwater.

Of course, the China and U.S. domestic growth and monetary policy narratives converge in the trade war discussions going on now. The continuing trade war is another head wind to growth. No doubt Powell had this scenario in mind when he opted to use the word “patient.”

The risk to investors is that markets are on a sugar high because of Powell’s recent comments. But the sugar will soon wear off and the Fed won’t provide more until March at the earliest. By then, the reality of slower growth in China and the U.S. and a lack of substantive progress in the trade wars will give the market a dose of reality like getting hit with a cold bucket of water in the face.

Evidence for this slowing comes from the latest Atlanta Fed update to their fourth-quarter GDP forecast, which now projects 2.6% growth after being as high as 3% earlier in the quarter.

What are the implications for investors of belated Fed ease combined with signs of weaker growth in China and the U.S.?

Right now, my models are saying that Powell’s verbal ease is too little too late. Damage to U.S. growth prospects has already been done by the Fed’s tightening since December 2016 and the Fed’s QT policy that started in October 2017.

The U.S., China and Europe are all slowing at the same time. Markets see this (despite Fed ease) and are preparing for a recession at best and a possible market crash at worst.

One potential catalyst is the start of the Chinese New Year celebration of the Year of the Pig. Kicking off with the Little New Year on Jan. 28, this celebration actually stretches over two weeks and is accompanied by reduced productivity and liquidity in Chinese markets. That’s a recipe for volatility.

We also have a Fed FOMC meeting on Jan. 30. No rate hike is expected, obviously, but there will be a written statement issued. Markets will be looking for the word “patient” in print, and if they don’t find it, there could be a violent reversal in the sugar high that started two Fridays ago.

Investors should prepare now before markets reprice.

Regards,

Jim Rickards
for The Daily Reckoning

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