July 30, 2021
By Steve Blumenthal
“We’re clearly on a path to a very strong labor market,
with high participation, low unemployment, and wages moving up…
it shouldn’t take that long” [to get there].
– Jerome Powell,
Chair of the Federal Reserve Board
In reaction to the 2008 financial crisis and ensuing recession, the Federal Reserve executed a policy known as quantitative easing (“QE”), which involves large purchases of bonds and other securities. In theory, this increases liquidity in the financial sector to maintain stability and promote economic growth. Stabilizing the financial sector encouraged lending to allow consumers to spend and businesses to invest.
Historically, QE, the monetary policy designed to infuse more dollars into the economy’s circulation, has been considered only usable as a short-term fix because of the danger that could arise from falling dollar values leading to hyperinflation. Traditional economists would insist that when the Fed feeds the economy for too long, there are unavoidable consequences. Tapering, which gradually reduces the amount of money the Fed pumps into the economy, should theoretically incrementally lessen the economy’s reliance on that money and allow the Fed to remove itself as the economy’s crutch.
However, since 2015, the Fed has found various ways to infuse cash into the economy without lowering the value of the dollar. These new policy tools, such as the repurchase window, may have ushered in a new chapter in the future study of macroeconomic policy. However, it will be several years before economists and academics, in hindsight, will be willing to declare such tools effective or dangerous. However, investor behavior always involves not just current conditions but expectations of future economic performance and Fed policy. If the public gets word that the Fed is planning to engage in tapering, panic can still ensue because people worry that the lack of money will trigger market instability. This is particularly a problem the more dependent the market has become on continued Fed support. (Source: Investopedia)
This week, the Fed got more aggressive with its words. Kate Marion from Axios captured it well,
Federal Reserve chair Jerome Powell’s Wednesday press conference focused on all things tapering, Axios’ Kate Marino writes.
Why it matters: With a rate liftoff not expected until the end of next year at the earliest, a tapering — or reduction — of the Fed’s $120 billion per month asset purchases will be the first significant pullback of its emergency pandemic market support.
- The last time the central bank pulled back on major asset purchases, in 2013, the surprise led to a Treasury sell-off — or “taper tantrum.” The Fed wants to avoid that this time.
State of play: The Federal Open Market Committee’s Wednesday statement says that the economy has made progress toward the committee’s goals — a prerequisite for tapering and an acknowledgment that wasn’t in its June statement.
What they’re saying: Powell said in the press conference that the committee discussed how it could adjust the pace and composition of the asset purchases — currently $80 billion in Treasuries and $40 billion in mortgage-backed securities.
- Composition is a hot topic as surging home prices have led to questions over whether the Fed should still be propping up the MBS market. Critics’ thinking is that the Fed should taper MBS sooner or faster than Treasury purchases.
- Powell knocked that down, saying there’s “little support” for that idea.
What’s next: The hunt for taper timing hints is on. The statement says the committee will continue to assess progress in coming meetings (plural) — leading many to surmise an announcement won’t come at the FOMC’s August Jackson Hole gathering or its September meeting.
The bottom line: Unless inflation rates jump high enough to worry the Fed, it’s all about jobs growth over the next few months. And Powell is pretty optimistic about the state of the labor market.
- “We’re clearly on a path to a very strong labor market, with high participation, low unemployment, and wages moving up,” Powell said, adding that “it shouldn’t take that long” to get there.
I write in Trade Signals (below) about the dollar’s intermediate-term trend and argue the trend is bullish (stronger dollar), not bearish as consensus believes. If a country prints too much currency, it destroys its value. The side effect is inflation. And we see signs of inflation due to supply chain shocks and worker shortages. Will it last? That’s the trillion-dollar taper tantrum question.
The Fed has been printing and buying $120 billion of Treasurys and mortgages each month. That new money goes into the system. Look at the increase since March of last year (COVID-19) and since 2008.
However, that new money is not moving through the system. The velocity of money is a measurement of the rate at which money is exchanged in an economy. It is the number of times that money moves from one entity to another. The velocity of money is important for measuring the rate at which money in circulation is used for purchasing goods and services. It is used to help economists and investors gauge the health and vitality of an economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is generally associated with recessions and contractions.
Note the decline in the velocity of money in this following chart.
Powell said there is little support for “tapering” mortgage purchases before Treasury purchases… The housing market is on fire, and the liquidity is flowing. It might be time to refinance your mortgage and front-run a future “tantrum.” I just did a quick search and found jumbo rates from 2.5% to 2.75%.
“If it is not transitory, and I hope it is,
then the weed of inflation grows and kills the garden.”
– Richard Fisher,
Former President and CEO of the Federal Reserve Bank of Dallas
In June, I wrote about Richard Fisher in an OMR piece titled “Inside The Fed – Richard Fisher” here. He said, “Talk about painting yourself into the corner; how do you get out now without bringing a downfall in markets at this delicate moment of the economy screamingly roaring back?”
By going slowly, the Fed may make the inflation problem worse. They signaled a warning towards tapering but not just yet. The takeaway from this week’s Fed meeting: The Fed is trying to prepare the people.
The GDP news this week gives the Fed more time to breathe. US GDP fell short of 8.5% expectations, coming in at 6.5%. Supply-chain disruptions and labor shortages were cited as the culprits.
Inflation is the tripwire. I believe Dr. Lacy Hunt is correct that the forces of debt and demographics are deflationary. I hope inflation is transitory. Bond yields (moving lower) and the dollar (moving higher) is supporting that view. And the trend in equity prices remains bullish. For now…
I was in Forbes this week with an article about the implications of margin debt and what it tells us about market euphoria. I provide a link below. In the Trade Signals blog this week, I talked about the flow of capital and the trend in the dollar (highlights below).
- “What Margin Debt Tells Us About Market Euphoria,” by Steve Blumenthal in Forbes
- Trade Signals – Capital Flows to the Dollar
- Personal Section – Boston, Maine, and Fishing
“What Margin Debt Tells Us About Market Euphoria” by Steve Blumenthal in Forbes
The “unwinding” of margin debt causes crashes. It sits today at an eye-popping high, but that’s not a bad thing at the moment. I like to put a moving average on margin debt, and when it drops below the moving average, a red warning light flashes. Currently, the light is green.
In my view, we are in a state of Euphoria. Here is the article. Please take a look and let me know what you think.
Trade Signals – Capital Flows to the Dollar
July 28, 2021
Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.
For new readers – Trade Signals is organized into three sections:
- Market Commentary
- Trade Signals — Dashboard of Indicators
- Charts with Explanations
Notable this week:
The dashboard is mostly green. The weight of trend evidence remains bullish for equities, high grade bonds, and gold. Though gold has been range-bound for several months.
With an eye on the dollar, here’s something to think about. The consensus view on the dollar is bearish. Analysts cite the massive increase in the money supply. Yet there is little evidence that the velocity of money is increasing. It inched up recently and is now trending down again… sitting near an all-time low. Debt in the US, while high (well, very high), is not nearly as bad as it is in Europe, China, and Asia. Capital flows where it is treated best.
I’ve been posting the dollar trend charts specifically to see what price may be telling us about capital flows. If money is flowing to US assets, it has to convert to dollars to buy stocks and bonds. Foreign investors tend to favor the DJIA. If there is a sovereign debt crisis in Europe, where will that money flow? It will flow to the US and distrusting governments it likely flows to equities. Therefore, a melt up can’t be ruled out. I’m not calling for it, just watching for it. On the crisis front, all remains quiet for now. We’ll see early evidence in the dollar. Keep it On Your Radar…
I share with you the weekly dollar chart next. I post it each week in the Charts section as well. The US dollar usually strengthens when the world economy weakens. That seems to be the message from both the bond market (lower bond yields) and the dollar today. The intermediate-term trend in the dollar remains bullish (green up arrows buy signals, red down arrows sell signals).
Click HERE to go to the balance of Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.
Personal Note – Boston, Maine, and Fishing
The Country Club and Francis Ouimet – Caddy to U.S. Open Champion in 1913 (Sources: Wikipedia and Golf Digest)
Francis Ouimet needed one putt to win and two putts to tie. His approach shot to the bowl-shaped 18th green left him 35-feet from the hole. He knew the course well. Ouimet grew up just across the street and qualified for the 1913 U.S. Open by winning the Massachusetts Amateur. Few knew him; no one took him seriously. Yet there he was, needing two putts to force a three-person 18-hole playoff.
The heavy favorites were English legends Harry Vardon (1900 U.S. Open winner; four-time British Open winner) and Ted Ray (reigning British Open champion). Ouimet’s first put went 3 feet past the hole. He made the next putt to force the playoff against the giants.
On September 20, 1913, the Colorado Springs Gazette reported:
An American youth—a stripling scarcely out of his’ teens—carved a niche for himself in international sporting history here today…. As the result of his exhibition of nerve and golfing skill, he will be America’s sole representative in an 18-hole three-ball medal play off of the tie which exists tonight…
When the spectators realized that in this homebred amateur, born and brought up on the edge of the County club course, rested America’s chance of winning the championship, they lost that placid attitude that ordinarily marks the golf galleries and rooted and cheered Ouimet in a manner typical of baseball and football games.
The scenes that attended Ouimet’s March over the last four holes have never been equaled on an American or European golf course.
Enthusiasm ran the gamut from despair to elation. When Ouimet’s second shot on the 18th hole landed dead on the edge of the home green, 5,000 spectators massed themselves in a gigantic ring of breathless humanity about Ouimet and his playing partner (caddie), George Sargent. The American youth need to hole out in one to win and in two to tie. He gazed long down into the bowl where the cup lay, dried his hands, and made a 35-foot putt that just missed the hole and rolled three feet beyond. A sigh arose from the crowd, and all was still again. Ouimet gently tapped the ball again. Slowly it rolled to the edge of the hole, curled around the lip for an inch or so, and then dropped in for the four which tied him with Ray and Vardon.
Instantly a tremendous yell went up. The gallery swept past ropes and guards and closed in on Ouimet in a solid phalanx. He was lifted to the shoulders of the advance guard and carried toward the clubhouse surrounded by several thousand cheering, yelling golfers who forgot their golf in the enthusiasm of being just Americans cheering an American victory. Many, not realizing that Ouimet was an amateur, thrust bills of large denominations at him only to be met with a smile and a shake of the head…”
“A gigantic ring of breathless humanity.” Love that… What a story.
My son Matthew and I will be flying to Boston early tomorrow morning. We land at 10:30 am and will Uber to The Country Club in Brookline, MA. Dear friend Dr. C invited us for a father-son match. Lucky, grateful, and very excited for the weekend ahead. A kind hat tip to my friend.
I’m going to take some time off from work the second week of August and a day off from writing OMR on August 13. Camp Kotok is approaching, August 12-15. Fishing on Grand Lake Stream, Maine… I have a lot of questions for my friends. And I’ll share what I am permitted to share with you.
David Kotok’s annual event is about fishing, friends, wine, and great debate. Gathered are former Fed officials, well-known economists, investors, and businesspeople. Opinions are diverse and conviction strong, as you might imagine. That’s a good thing in my view, and it makes for lively debates that challenge hardened views.
I’d like to debate possible pathways to solving the global debt and underfunded pension challenges. I have some ideas. And perhaps, in canoes with minds relaxed and fishing rods in hands – brilliance will strike. We need solutions! And we also need some fish for a successful lunch. The wine has already been caught.
I hope you find some peaceful downtime in August… and always.
All the best,
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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