Two Hawks Retiring
We had a solid bounce yesterday as we saw the broader base Russell get into the top of the consolidation range. If we can see some consolidation on volume in the 1120 area, we could see a rally off these lows. However, my conviction is not based on sound economic fundamentals or growth and certainly not on the headline GDP, U3, or CPI. It is based solely on the Fed monetary policy and zero rates. However, can the Fed keep this market strong? I believe they will try – especially heading into the mid-term election. Yet the forces of supply and demand will continue to put real fundamental pressure on this market.
Last night I gave a lecture for the Investment Business Daily (IBD) group about hedging positions using options and of course (as per usual) I couldn’t stay on topic and we eventually reverted to the broader economics of the market and WHY the market is rallying as well as the Fed.
I lead the tangent on how we as members of a democratic society can be easily fired up about the Supreme Court nominees and all the hot push-button topics that funnel us into one camp or another; gay marriage, prayer in school, gun control, abortion, flag burning, immigration, drugs, you name the social issue and one certainly has a strong emotional opinion on one side or another. Politicians know this well and with the help of the media, use the appointment process of Supreme Court Justices as point to make a vocal stand on the issues to win voters. It works, the media feeds it, and we FEEL that democracy is at work, perhaps it is.
Supreme Court Justices – courtesy of wikipedia
Yet, as I pointed out after making this realization, the same process happens with the Federal Reserve Chair and the board of governors and we the people and politicians take no issues with the process. No doubt this last appointment of Yellen turned into a little bit of a media circus, but that was not based on issues that drove voters but rather some inside baseball as Larry Summers thought that he was promised the position by Obama way back when he was in the good graces of the President in the first term. It was Larry’s own camp that leaked that he was a possible candidate that started the circus act.
Unfortunately, while making for some fighting in the belt-way the rest of the media and voters paid little attention or even cared. Politicians use the appointments of Fed Chairs and governors for some horse-trading for ear marks, because that’s all it’s good for. You are not going to see politicians out their stumping for Fed governors like they do justices for the Supreme Court, because they know it is a waste of time to use it as a tool to garner votes. The fact is the American people are ignorant of whom and how the Fed works, they have little understanding of money, bonds, interest rates, and Fed policy. However, as any American on the street about gay marriage, gun control, or legalization of drugs and they ALL have an opinion and that opinion will clearly side with one-side or another on the Supreme Court. Ask the same group of people any economic question about monetary policy, QE, or interest rates and they will look dumb founded.
Math impacts us all!
Last night I was very clear, that unlike ANY other social policy, the math of economics and monetary policy doesn’t know black from white, old from young, gay from straight, Christian from Jew; it is simply math devoid of bias or bigotry. Everyone that room last night is directly and indirectly impacted by monetary policies – we all earn dollars, spend dollars, invest dollars, and hopefully save dollars. One should take ample consideration and understanding of WHAT is really going on and not blindly trust in a sound bite or headline data point that everything is hunky dory.
Getting back the Supreme Court vs. Federal Reserve analogy I pointed out to the audience that the President, much like the Supreme Court appoints the positions of Chair and governor. I then pointed out that for the first time in decades that the entire board of governors as well as Chair has been appointed by one President. Imagine if Obama or Bush was able to appoint every Justice on the Supreme Court, we would most likely have a very one sided Supreme Court. Fortunately, the Supreme Court is fairly equally divided currently, we have 4 liberal justices, 4 conservative justices, and 1 swing vote justice (Kennedy). The Federal Reserve however is now completely dominated by Doves that fall under one specific economic school of thought known as Keynesian economics.
There are seven President appointed board of governors, including the Chair. Governors serve a 14 year term and because of this extend term, historically Presidents may appoint a few and once in a blue moon an majority, as Fed governor terms far exceed a Presidents term, even two term presidents. President Obama has been fortunate (or unfortunate) to be able to completely appoint ALL the governors. Janet Yellen is the new Fed Chair (her term as Chair ends 2018, but she would remain a governors until 2024). Stanley Fischer was recently appointed to Vice Chair. There is Tarullo, Powell, and most recently Brainard, all appointed by Obama. That makes 5 governors appointed by a single president, so what about the two others governors? Well those seats currently remain vacant and he will certainly be appointing those two as well, but most likely after the mid-terms.
Courtesy of bloomberg
The one common theme among these appointed governors is that they are all of the same economic theoretical mindset, Keynesians with Dovish leanings to one degree or another. That means they all have a similar view, there is no discontent or real debate among them. They all believe and view economics from the same mindset. Additionally, unlike Congress or even the Supreme Court the Fed’s policy is not democratically decided. While they do “vote” on policy it is ultimately up to the Chair, Yellen. However, with a likeminded set of governors, who will oppose her?
I have read several of Yellen’s papers and lectures prior to her role as Chair. One can learn a lot about someone from their writings, lectures, interviews and speeches. Yet I hear media pundits and even a few economist refer and describe her as a more moderate and sometimes even Hawkish, which is directly opposite of her papers, lectures, and even past remarks as Vice-Chair and SF Fed President. I am not sure why they would describer he in such fashion, perhaps they don’t see or hope that she is not as her historical records suggest.
So who is to stop this onslaught of Keynesian Doves that have now dominated the Federal Reserve? Frankly there is really no one that can completely oppose and stop them, yet there remain a couple of voices inside the Fed that remain critical and have opposed the uber-long-term accommodative measures of the Fed. These are a few of the Fed Presidents.
Not to be confused with the President appointed Fed governors, the Fed Presidents are the heads of each of the Federal Reserve Banks. There are twelve Federal Reserve Banks and each one of these banks has a President, whom is NOT appointed by the President of the United States. These bank presidents, known as Federal Reserve Presidents, are given a voice at the Federal Reserve and during the Federal Reserve Open Market Committee meeting (aka FOMC meetings).
The FOMC is the multi-day meeting in which our Federal Reserve determines monetary policy and then they issue a statement. Historically their only tool has been to set short-term interest rates (Fed Funds Rate or Target Rate), which all other rates around the world are based – primarily because the US Dollar is the world’s reserve currency. Since the recent crisis they have expanded their powers, under the auspicious of saving the economy. These powers are encompassed and marketed as “Quantitative Easing (QE)” and have been referred to by the Fed as “extraordinary measures” or “extended emergency measures”.
The FOMC meeting included all 7 governors (currently only 5) and the NY Reserve Bank President, the other members of the FOMC meeting are in rotation as each of the remains 11 Reserve Bank Presidents are given turns to share their views in an “official” capacity and VOTE on policy. By design the Federal Reserve FOMC is dominated by the President appointed governors, who always carry the majority. However, there was hope – much like the Supreme Court, that no single sitting President could stack the bench of governors with a single economic view, hence the 14 year terms.
Currently two of the Federal Reserve Presidents, Dallas Fed President Fisher and Philadelphia Fed President Plosser are voting members in the FOMC. It’s their turn and these two gentlemen are not carved from the same Keynesian Dovish cloth as their fellow Obama appointed governors are. While Dallas Fed Fisher has historically been vocal of the Fed uber-accommodative polices since the beginning of the crisis and has generally opposed the ongoing rule out of QE2, Operation Twist, QE3 as well as keeping rates at zero for extended periods of time, now he is a voting member in the FOMC.
The last FOMC meeting, both Fisher and Plosser, the two non-presidents appointed members, voted AGAINST the current Fed statement and broader policy implications.
They are concerned, very concerned that the Fed has “Crossed the Rubicon”. They have been publically vocal about it as well as within the halls of the Fed. One can read the minutes, which are released months later and reading through them – there concerns are warranted. Yet it seems that Yellen and her fellow Keynesian Doves don’t wish to hear it, don’t believe it, blinded by their own ideology, or perhaps have some marching orders as some conspiracies have suggested. I am in the camp they are just blinded by their decades of Keynesian indoctrination.
Do Fisher’s and Plosser’s votes count? Not really, it is just a footnote in the FOMC statement that they disagree. The Fed, unlike Congress or the Supreme Court is NOT a democracy in the true sense. The Chair, Yellen, has ultimate authority and power. She COULD listen to the voting members, but she is not obligated to set policy based on a democrat vote. From my brief review of Fed history, this however has never been tested. I have yet to find a single time in our Fed history in which the Chair has made a decision that has gone against the majority vote of the FOMC members. I also believe that will NOT happen, not with this appointed Fed – because as I have pointed out all the governors have been appointed by one president. There will be no coup in the Fed, because you could say the coup has already happened as one president has been able to stack the bench with like-minded individuals.
Fisher and Plosser’s outspoken voices are needed, they keep a check and balance in place, and they have brought forth REAL concern based on math, reason, and logic. Unfortunately both of these FOMC members are retiring, stepping down, perhaps giving up. Are they tired of debating against the stacked bench of governors? Do they see no hope in the near future? Have they come to terms that perhaps the Fed’s role has changed permanently – that zero interest rates and Fed intervention is here to stay? Is the Free Market Interest Rate environment over?
Courtesy of wikipedia
Fed Fiscal Policies?
I have gone out on a further limb in the past, by commenting on the possibility of the Fed expanding their role into the fiscal policy realm. For if you give the Fed a dual mandate, one including “full employment” (note we are the central bank that has been charged with such a mandate), that they will need the tools – which will require fiscal policy making – for them to reach “full employment”. If Yellen’s papers and theoretical social fiscal policy papers are any measure and would be adopted, we could see an expansion of interventionism into the private sector with mandated wage controls and government subsidies. Has Fisher and Plosser drawn the same conclusions that I have, have they read Yellen’s papers?
What has happened under the Obama administration was never intended or supposed to happen. Of course this is NOT Obama’s fault, but by circumstance as several governors have resigned and this has created a rather absurd and unusual position. Of course the conspiracies theorist out there have stated this is by design and some members that had recently resigned, did so by coercion from some supposed cabal in the administration. However, we don’t have to even give conspiracies theories weight because the fact is very clear – like it or not, the situation has publicly materialized in which all governors must be appointed by one sitting President.
It is foolish to believe, regardless of political persuasion, that sitting President would NOT want to stack the bench of Federal Reserve governors with like-minded ideology that fits with their agenda. Of course they would, just like they would with Supreme Court justices.
So here we are, with 5 permanent voting members (governors) selected by a single President, with two more seats to fill. Is it coincidence or by design that they all share the same economic school of thought, does it really matter at this point. The fact remains, conspiracies or not, the Fed governors are now of all one very narrow Keynesian economic mindset, which embraces more social reforms and even fiscal policies.
I personally can’t see how we will see the Fed return to “normalization” and free market interest rate environments in the near future or even the foreseeable future.
I was asked last night, “But QE is winding down!” I responded, “That is only OPTICS!” I it true that NEW money used to FUND government deficit spending by purchasing bonds can eventually come to an end, the answer is simple – there is now over $4 trillion in short-term maturities that continue to come due.
The Fed is just rolling their massive balance sheet, as 100s of billions of short maturities come due; they use the principal to repurchase more. The Fed is now just rolling a $4+ balance sheet of debt to continue to fund deficit spending. They don’t need to print more if they have enough maturing and freeing up capital. Unless – of course – deficits rise.
The subject of interest rates is also an easy one to consider, it is simply the “chicken / egg” problem. If you want to end QE and/or Fed accommodation (buying bonds) completely, you have to find some else to buy them instead. The only way to generate interest to purchase bonds is to offer a compelling interest rate. However, if you raise the interest rates you could not only stall economic growth, but you further increase government deficit spending because the interest on debt would increase (currently about $500 billion per year). Hence – the Fed is stuck – they can’t raise rates because it would stall economic growth and also raise government deficits because of the whopping debt, so they are unable to find buyers of government bonds. So the circle continues.
The Fed isn’t stupid, they know this and so does Plosser and Fisher. The two Hawks that are retiring understand that it will be painful and will impact both the government and the economy; however they have clearly repeated we can’t live in this debt expansion and uber-accommodation forever – it must end and it will end.
The long-term real question is simple;
Will it end by responsible and accountable, yet painful choices by the Fed that weans us off the teat of accommodation and getting us back to the free market interest rate environment
Will it come when the levee breaks as the unstoppable power of the free market forces of the law of supply and demand engulf us in a watershed moment that could bring unknown and known problems – such as hyperinflation or mass devaluation?
Is History a measure?
I reminded the audience last night, it happened once before – starting in 1979. Our nation faced high inflation and the Fed was worried that at any month, week, even day that hyper-inflation was at our doorstep. The same power of that wiped out many nations before. Volcker, the Fed Chair at the time, took the extremely unpopular decision of raising rates fast and hard, he had too. The choice to Volcker became abundantly clear, to see rampant and uncontrolled hyperinflation as the dollar would be another static of failed fiat currencies in annuals of history OR to tighten and bring back value to the dollar and hope to live another day. Volcker’s decision was very painful, he had no friends, and he knew it would hurt economic growth, increase unemployment, and perhaps even stall or contract economic activity. However, to hell with the economy and jobs if the dollar becomes worthless and hyperinflation seizes hold. Volcker had some huge balls and did what many would be too afraid to do – he was hated by many, but in the end saved the dollar. Does Yellen and her Keynesian governors have the balls to do what needs to be done when the time comes? I am not sure and I have little faith they will because it will be admitting their long-term monetary policy has not only failed, but was the cause of the problem. They would have to come to the realization that their Keynesian ideology is flawed and their broader collectivism views of central planning can never stem the tide of the laws of supply and demand.
Fed Chair, Volcker, courtesy of wikipedia
Rates under Volcker (1975-1979 NY Fed President / 1979-1987 Fed Chair)
I seriously hope I am wrong and that this day of reckoning that will separate those from doing right does not come to past or not in my or my son’s life time, but if I were to remain objective and to apply only reason, logic, and math – the day is coming. Plosser and Fisher know this and they are in the inner sanctum of the Fed, soon they will be no longer in the club and there will be a full bench of 7 governors – all marching together towards some ideological Keynesian collectivist future of central planning government knows best, while ignoring the math.
The hawks retiring is a bad omen for me.
Support & Resistance
Yesterday’s bounce as good, but will it be sustainable. The fundamentals remain weak and we remain reliant on accommodative policies. Continue to monitor the 17,000 level for support if we do get a pull back today after yesterday’s sort-of hopeful rally.
NDX 4000 – 4100
This is the range for now and I suspect some volatility. The Alibaba IPO has been a bust for those that got in since it was listed and now Apple is fumbling with their new iPhone (bends, OS update problems, and now a major bug/hack) – Jobs is rolling over in his grave.
This is the rough support, not holding well into these levels means we could see a larger collapse down to the 1960 or 1940 levels. The VIX is pricing in risk but has not gone into panic mode yet. If we see weakness hit the market today – we could see the VIX push up into the 16 range, especially if we break the 1980 support area.
We had a good move higher on the RUT, which I continue to watch for general order flow into or out of the market. However, it didn’t’ get to that 1130 level that I had hoped for and volume wasn’t strong. I continue to watch the 1110 – 1120 as short-term support, with broader support at the 1090-1110 range. If we can consolidate at any of these levels – we could form a base to gain another rally going forward, if not – we have a ways to fall.
In the Fed’s Hands!
Don’t look to economic data, earnings, iPhones, or even whopping IPOs to drive this market higher. It comes down to the Fed policy. The Fed has to inject more money and eliminate any concern that rates are going up soon. Of course I believe and know that to be the case, but the market must be convinced of that.
The market is under pressure because the Fed is being assaulted in a currency devaluation war with Japan (BOJ) and Europe (ECB), who have both fired massive amounts of accommodation into the global markets. This is pushing up the dollar and as the dollar goes higher the more it will deflate the equity markets.
How long can Yellen hold on before firing back? Is the mid-terms handcuffing her, because while the market and exports are getting blasted by the Yen and Euro, the US Consumer’s dollar is going a little farther as imported goods, services, and gas prices are falling?
The mid-term elections are a short way off, when measured in political time-lines, but 60 days out can by massive percentage points in market time-lines.