QE or Not QE: The Consequences Are The Same

It may look, swim and quack like one, but Federal Reserve Chair Jerome Powell insists that the Fed’s recent reinflation of its balance sheet past the $4 trillion mark isn’t quantitative easing. Oh no, he says, just because the Fed’s portfolio recently rebounded to $4.175 trillion at the middle of January, up from a six-year low of $3.76 trillion since the beginning of September, doesn’t mean that the Fed is back to its old QE ways, which had pushed the Fed’s balance sheet to a steady $4.5 trillion between 2014 and 2018 when it started to shrink.

But QE by any other name is still QE.

At least one voting member of the Fed’s monetary policy committee has expressed some concern about the recent boost in the Fed’s balance sheet – more than $400 billion in just the past four months.

“The Fed balance sheet is not free and growing the balance sheet has costs,” Robert Kaplan, the president of the Dallas Fed, told reporters at a recent Economic Club of New York event, according to the Wall Street Journal. “Many market participants believe that growth in the Fed balance sheet is supportive of higher valuations and risk assets. [That’s Fed-speak for a bubble]. I’m sympathetic to that concern.”

For the past 12 years, ever since the financial crisis in 2008, the Fed has swollen the size of its balance sheet – its holdings of U.S. Treasury and government-insured mortgage-backed securities – from less than $1 trillion to more than four times that. Its first burst of bond-buying took place in 2008, during the depths of the meltdown when its portfolio more than doubled in less than a year. It then gradually increased to more than $3 trillion over the next five years, at which time QE took it to $4.5 trillion, where it held steady until 2018, when the Fed started to allow its holdings to run off as they matured, until its recent policy U-turn.

And what was the direct result of all that buying? Continue reading "QE or Not QE: The Consequences Are The Same"

The Fed's Newest Service: Portfolio Insurance

Every generation believes that they know more than the previous generation. Then, as they get older, they slowly start to realize that their elders aren’t as dumb as they thought. It's normal.

What's different today is that we seem to think, or at least many people do, that not only are we wiser today than everyone who has come before us but that humankind has been doing everything wrong for the past 5,000 years or so of civilization. Whether it's morally wrong to eat meat, or how many genders there are, or who can marry who, or whatever, it seems that we've been misguided since the beginning of time.

This attitude also manifests itself in the economic sphere. Based on the Federal Reserve’s recent actions, they appear to believe that everything we knew or thought we knew about economic cycles and bull and bear markets has been all wrong. Thousands of years of boom and bust cycles could have been eliminated, apparently, if only the proper monetary policy fixes had been applied.

Quite clearly, the Fed’s new mandate is that if economic growth starts to sputter, or the stock market moves beyond a correction, or some international crisis – Brexit, Megxit, Iran, North Korea, trade wars, you name it – threatens to upset the applecart, it will immediately turn its monetary policy tools into high gear.

Before now, economic growth and stock prices were pretty much allowed to take their own course, with some attempts to smooth out the worst excesses. It was considered to be both normal and healthy for markets and economies to go up and down periodically, as long as the general trend was upward. Now, however, that appears to be not only quaint, old-fashioned thinking but just plain wrong. There is no reason, the thinking goes, for us to suffer any economic pain as long as we have the policy tools to avoid it. Continue reading "The Fed's Newest Service: Portfolio Insurance"

The Times They Are A' Changin'

Talk about charter creep. This is more like a charter leap.

As we know well by now, the Federal Reserve’s famous “dual mandate” is to promote price stability and maximum sustainable employment. But as we also know, the Fed really has a third mandate, maintaining moderate long-term interest rates (don’t ask me why they still call it a dual mandate).

So it should be no surprise, then, that the Fed has now gone way beyond that dual (or treble) mandate by wholeheartedly injecting itself into what is really a political debate, namely climate change. And how ironic it is that it rose to the forefront during the same week that the U.S. withdrew from the Paris Climate Agreement.

Last week Fed officials were out in force, declaring that climate change would now be a major factor in not only how it regulates federally chartered commercial banks but also how it conducts U.S. monetary policy.

On Thursday, in a speech at the GARP Global Risk Forum, Kevin Stiroh, an executive vice president responsible for regulating banks at the New York Fed, said financial firms need to take the dangers and costs of climate change into their risk-management decisions.

“Climate change has significant consequences for the U.S. economy and financial sector through slowing productivity growth, asset revaluations, and sectoral reallocations of business activity,” he said. “The U.S. economy has experienced more than $500 billion in direct losses over the last five years due to climate and weather-related events.” Continue reading "The Times They Are A' Changin'"

Happy Halloween

The last week of October is likely to be an eventful one. Halloween is on Thursday, the last day of the month, and Major League Baseball will crown a new World Series champion. And, oh yes, the Federal Reserve will hold its next-to-last monetary policy meeting this year, at which it is expected to continue on its path of easing monetary policy in the face of not-so-terrible economic news that doesn’t appear to warrant another interest rate cut.

The Fed meeting begins on Tuesday and culminates on Wednesday afternoon at 2:00 EST, with a likely announcement that it is cutting its federal funds rate by 25 basis points for the third time in as many meetings. The Fed hasn’t cut rates this often since the financial crisis when the world economy and financial markets looked like the world was coming to an end. Now we’re looking at the U.S. economy weakening from about a 3% annual growth rate to about 2%, and the Fed is acting like its 2008 again.

Of course, the Fed may not be looking to do another rate cut for economic reasons, but because it has pretty much painted itself into a corner by practically promising the markets that yet another rate cut is coming. What would the market’s reaction be if the Fed decides on Wednesday to leave rates unchanged? No doubt it would be ugly, which is why I’m siding with the consensus market view that the Fed will indeed lower rates this week, whether it’s “data-driven” or not.

Speaking of data, Continue reading "Happy Halloween"

What If They Had A Recession And Nobody Came?

There are two main constituencies in the U.S. that are hoping for a recession. The financial markets, both stocks, and bonds seem to have a vested financial interest in there being one.

For the bond market, which has been the biggest rooter for a recession, a weak economy means lower loan demand and lower interest rates, which means higher bond prices. For the stock market, a weaker economy, although not necessarily a full-blown recession, promises more accommodation from the Federal Reserve and, therefore, lower interest rates, which generally translates into higher corporate earnings and, therefore, higher stock prices.

The Democrat Party and its allies in the press naturally want a recession simply because it makes it less likely that President Trump will be re-elected. So they are rooting strongly for a recession, although they can’t actually come out and say so.

The recession lobby got some fresh ammunition last week when the Institute for Supply Management’s purchasing managers’ indexes for September came out. They were some of the worst in years, which ignited a rally in the bond market.

On Tuesday, the ISM manufacturing index slipped further into contraction territory, dropping more than a point from 49.1 in August to 47.8, its lowest level since June 2009, during the Great Recession (there’s that word again).

Unfortunately for the pro-recession crowd, a lot of the rest of the economic numbers aren't telling the same story. The ISM’s index for the services sector – which covers about three-quarters of economic activity – also came in lower than expected, dropping nearly four points from 56.4 to 52.6, its slowest pace in three years. But it remained well in expansion mode (i.e., over 50). That part of the story got little attention. Continue reading "What If They Had A Recession And Nobody Came?"