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Peter Schiff Warns "The Shadow Rate" Casts Gloom
Submitted by Peter Schiff via Euro Pacific Capital,
Nearly 92% of economists surveyed this week by the Wall Street Journal expect that our eight-year experiment with unprecedented monetary easing from the Federal Reserve will come to an end at the next Fed meeting in December. Since we have had the monetary wind at our back for so many years, at least a few have begun to question our ability to make economic and financial gains against actual headwinds. But in reality, the tightening cycle that the forecasters are waiting for actually started last year. Sadly, the markets and the economy are already showing an inability to handle it.
While it’s true that we have yet to achieve “lift-off” from zero percent interest rates, rates have not been the only means by which the Fed has provided stimulus. We also have to account for the effects of Quantitative Easing (QE) and forward guidance of the Fed. Changes in those inputs over the past year have already created conditions of monetary tightening.
QE has been the process by which the central bank expands its balance sheet (otherwise known as printing money) to buy government and asset-backed bonds on the longer end of the duration spectrum. In so doing, it is able to help hold down long-term interest rates, a result that it would be difficult to achieve by changes in the federal funds rate. Zero percent interest rates represent a loose monetary policy, but once at the zero lower bound, QE is the way the bank eases even further.
Another big input is Fed “forward guidance.” This comes in the form of official and unofficial pronouncements from top Fed policy makers as to the possible trajectory of rates in the future. If the Fed communicates that rates will stay low, or QE will remain in place, for some time, then policy becomes looser still. Such assurances effectively remove near term interest rate risk, which stimulates financial activity. Ever since the Financial Crisis of 2008, the Fed has engaged in unprecedented forward guidance, without which monetary conditions could have been expected to be tighter.
To account for these important factors, University of Chicago professors Cynthia Wu and Fan Dora Xia, constructed a model for the “Shadow Rate.” While the fed funds rate has remained between 0.0% and 0.25% ever since November of 2008 (Federal Reserve Board), the Shadow Rate moved much lower, factoring in the effects of QE and forward guidance. That rate got as low as -2.99% in May of 2014. (Federal Reserve Bank of Atlanta, CQER, Shadow Rate)
But the Fed’s QE tapering campaign, which gradually reduced the amount of securities purchased monthly by the Fed, effectively began a campaign of monetary tightening that helped push up the Shadow Rate sharply even as the fed funds rate itself did not budge. After QE was officially wound down in October 2014, the Fed began to change its forward guidance to actively suggest that a long-term campaign to lift interest rates would begin in 2015. This also worked to help tighten monetary conditions. As a result, the Shadow Rate moved up from -2.99% in May of 2014 to just -.74% in September of 2015, (FRB Atlanta, CQER, Shadow Rate) an increase of 225 basis points in just over a year.
This is a fairly robust tightening trajectory that can be said to have clearly taken a toll. Since January of this year, the major market index, the S&P 500, has essentially been flat. While in contrast, it had been up by double-digits in five of the last six calendar years. Similarly, GDP growth has slowed considerably in the months since the QE program was finally tapered down to zero in October of 2014.
U.S. stock investors may be complacent regarding the ability of the stock market to withstand higher interest rates. Their confidence may come from the fact that, historically, markets have not peaked until 12-24 months after the Fed begins to tighten. This assumes the tightening cycle begins with the first official rate hike. But if it really began with the increase in the Shadow Rate, then a December rate hike will already be 19 months into the tightening cycle! Plus, given how overvalued stocks may currently be, and the amount of corporate debt accumulated to finance share buybacks, this bull market may be far more vulnerable than most to higher interest rates.
The last three times that the Fed had conducted a rate tightening cycle (1986-1989, 1994-2000 and 2004-2006), the increases in rates averaged 388 basis points. But those moves upward occurred when QE did not exist and when forward guidance was hardly a factor (the Fed only started doing press conferences in the last few years). So the tightening that has occurred to the Shadow Rate in the last year is already 58% of the size of the average of the last three tightening cycles.
Created by Euro Pacific Capital with Data from Bloomberg
If the Fed does as it has suggested it will, and takes fed funds up to 2.6% by the end of 2017 (which is the Fed’s own median forecast), then the total effective move (that includes the tightening of the Shadow Rate) would be a tightening of 559 basis points, well larger than the average of the last three tightening cycles. Does anyone really believe that our fragile and slowing economy can deal with that kind of headwind?
Generally, the Fed tends to wait until the economy is on solid footing before tightening. For instance, in the 12 months prior to the 390 basis point tightening that occurred between 1986-1989, real GDP was 3.2%. GDP was 2.65% in 1993, the year before a six-year tightening cycle raised rates by 350 basis points. GDP was a solid 4.3% in 2003, the year before Alan Greenspan began raising rates in 2004, a move that took up fed funds by 425 basis points. But current GDP, which is somewhere around 2.0% over the past four quarters, is not nearly as robust. (Bureau of Economic Analysis)
But what’s more concerning is the magnitude of the easing cycle that has gotten us to this point. It began in 2007, lasted a full 80 months, and took the effective fed funds rate (accounting for the Shadow Rate) down by 825 basis points. In contrast, the prior two easing cycles averaged 612 basis points and 34.5 months. This huge dose of stimulus is certain to have caused distortions in the economy that won’t be seen until we get more normalized levels of monetary policy. As Warren Buffet has most famously quipped, “We have to wait till the tide goes out before we see who has been swimming without bathing suits.”
Since the Second World War, recessions have begun, on average, every seven years. Since the current recovery is already seven years old, how much longer should we expect this historically anemic recovery to last? If the slowdown occurs next year, can we really expect the Fed to remain on the sidelines and risk the possibility that the economy goes into a recession leading into a presidential election? Both the chairperson and vice chairman of the Fed are solidly associated with the left side of the political spectrum. Should we expect that they would be hesitant to support the markets and the economy and thereby create conditions that might help Republicans take the White House?
Nevertheless, most people assume that rates are on the way up to 2% or more. But from my perspective it’s much more likely that the rates never get close to that level. I would argue that any positive rate of interest would be enough to stop this economy cold. Years of negative rates have so corrupted our economy that I believe it is now fully addicted and cannot survive under any other condition.
Since this historically weak recovery is already decelerating, one might expect the removal of stimulus could cause the next recession to start quicker and be far deeper than any experienced in the past. Since the Fed may recognize this, the next easing cycle could likely start much sooner, and the accompanying monetary stimulus be much larger than just about anyone believes.
Each of the last three easing cycles took rates lower than where they were at the end of the prior easing cycle. Given that the fed funds rate is at zero (and the Shadow Rate got to as low as -2.99%), one shudders to think how low the Fed is prepared to go the next time around. As a result, investors may want to consider re-positioning their assets for another period of possible monetary easing not a period of tightening, which I believe, in fact, is already well underway and will soon be a thing of the past. December is far less significant than what almost everyone has been led to believe.
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What's the percentage increase in rates of a 25 bps rise when your denominator is zero?
The Fed won't tighten in December.
This is how will war between Russia and America look like and how to protect yourself when war happens.
http://motivationdose.com/alive-after-the-fall/
Print bitch
"Years of negative rates have so corrupted our economy that I believe it is now fully addicted and cannot survive under any other condition."
The economy (market) will not survive at any level regardless of rates.
The Bankster Cabal != The Economy
Stop repeat lie.
You could be right, Sonic. Doc Engali would agree with you and he beat me out of a sandwich over that very issue.
Really at this point it's between whether the Fed wants to crash the financial world with a rate increase or crash whatever is left of their own credibility by not raising rates. Decisions, decisions.
If they're going to walk back the rate increase talk it will start happening very shortly before the meeting not now (lots of talk about negative economic indicators, blah, blah, blah.) They'll make it sound like it just happened all of a sudden shortly before the meeting.
Unless, of course, some unplanned 'event' occurs before their December meeting, allowing them to wiggle out of raising rates but instead go into full blown QE.
Wait What has been thinking much about that "full blown QE" that increasingly appears necessary. How much QE? Will the markets think it isn't enough if it isn't bigger than QE3, and subsequently dump? What options will the Fed have if despite a new round of bond buying 'inflation' still falls? Even MOAR? How ready is the Fed to own 50% of the TSY market, considering the liquidity impairment obvious now? Are the diminishing returns of QE now obvious, necessitating a different monetary experiment?
Wait What has begun to look at a December rate hike as sufficient and necessary to financial stability. It's the one thing no Fed speaker has mentioned, or can mention, so they continually use the smoke-screen of 'getting better' to avoid those 2 words. But it's become obvious that risks of further QE now outweight the benefits it might provide. Fed hikes in December, not because it wants to, or because the economy can handle it, but like in 1979, because it has to. the window of appropriateness is quickly closing, so if it's every going to do it, 1 month from now will be its last chance. Then, no further rate hikes as far as the eye can see.
<<<< What's the percentage increase in rates of a 25 bps rise when your denominator is zero? >>>
This is the same as: It is 0 degrees outside and the forecast is that it will be twice as cold tomorrow, then what will the temp be tomorrow?
There is actually a solution to that question if you use the comfort temperature for winter of approx. 70 degrees and you double it, you have -70 which is almost impossible.
How about this: Someone told you that it is -40 degrees outside, do you have to ask if that is Celsius or Fahrenheit?
I'd say Peter is spot on. I hope the FED does raise interest rates. That should be fun.
What we have now is "The Charge of the Light brigade" and didn't that end well......?
You lost me at the names of those two broads who wrote the whatever paper. PRC academics at the University of Chicago.
SMFH.
That sort of "study" is bought and paid for.
You took the words right out of my mouth. I've watched over the last few decades as the quality of scientific literature has fallen off dramatically, mostly due to the influx of PRC and Indian researchers into US academia. I didn't start off with any bias, but after a while in grad school it became readily apparent that the quality of work just wasn't there. These days, when I see a paper with only Asian authors (excluding Japanese as they still do solid work), I just delete it.
Hey Tyler,
What the fuck? You are never going to expand your audience of Israel and Jew bashers here on ifuckinghateisrael.com by posting these types of tedious financial stories. Your new breed of members clearly are not interested in any report where they cannot circle jerk each other repeatedly over Israel. This type of stuff isn't doing it for them judging by how few comments have been left here.
'to account for these important factors, University of Chicago professors Cynthia Wu and Fan Dora Xia, constructed a model for the “Shadow Rate.”'
I stopped reading at that point.
Fuck off, Peter.
Good strategy. Bet you use it a lot.
I'm beginning to believe that the "new breed" of ZH posters are "economic illiterates".
I'm not a "Jew" but I'm also tired of these same Jew bashers blaming EVERYTHING shitty going on in the world on the Wall Street Jews, et al.
What happened to the intelligent discussion(s) that used to be a big part of ZeroHedge??????????????
Tyler?
What you're saying is the narrative has changed and you don't like it. I'm not a "Jew" either, but Manaement of Perception Economics isn't a strategy for real prosperity.
No. I don't like the so-called narrative these days. It's full of juvenile bullshit. There's not nearly as much serious discussion of ZH's published articles. Just the silly carping and bitching blaming everything on the Jews of Wall Street and Israel.
I used to enjoy serious discussion of the articles published and reprinted here. Now I just read the articles and move on since there isn't anything worth my time reading below most of the articles these days.
And yes, I know this is "Fight Club Rules", so fuck off.
:)
hairball
It is really hard to have a serious discussion when the fact is that whatever remaining transparency, price discovery, or honesty in all the economic data was left has now been completely destroyed. Ergo, jump you fuckers!!!
Yes, human technology evolves. Human behavior does not. The moral hazard that has been unleased by bankers, financiers, and their political puppets is the likes of something the world has never seen. Think about it, hundreds of trillions of paper claims on real assets that do not exist...
prepare.
True that. Kind of like predicting the weather in a machine with a trillion cogs of different sizes, but mostly small. The big cogs have been oiled with a new lubricant; sadly what used to be more symbiotic sharing during the real capitalism phase became illegally greedy and short sighted oligarchial socalism, leaning towards tyranical feudilism. The demand isnt present to keep the wheels turning. More Qe will just slowly erode capitalism away. Many small cogs will die.
I'm not an economystic, but they do not seem to have noticed the deflation in commodity prices, which makes the idea of a rate hike completely absurd. The fact that the Fed can continue to reset the market's expectation for a rate rise that will not happen is a good example of the madness of crowds. The Fed cannot raise rates without causing a massive dislocation in world debt financing, yet if it admits the fact, that will cause a massive dislocation in the world's reserve currency. So how many Fed Lucy footballs is the Charlie Brown market going to attempt to kick?
From the point of view of Goldman Sachs, that basically has its provincial field office in the Eccles building, these are the best of times because being connected to the Fed when the world's markets are looking only at the Fed, and nothing else, assures that those who have an inside at the Fed will always front run the market muppets.
And so it goes.
Fed won't tighten in Decenber and will avoid further rate hike talk.
Talk of QE4 next year. QE until a currency crisis.
shadow rates are nothing more than expected inflation, (the lower depth of the shadow rate in the most recent cycle reflects the amount of (excess) stimulus, QE, which will eventually manifest itself in higher prices, (too much money chasing too few goods) and you can see that in the CPI tables.
if energy prices rebound in a meaningful way inflation will pass their 2% target quite easily. right now there is too much oil, but that can reverse itself suddenly as we saw in the 70s with the arab oil embargo, in the current context once the monetary excess and associated hedge fund investment is over, no more fracking and shale oil, then supply will retreat, at a moment when inflation in all other categories, especially services, begins to ramp up.
there will be a moment when fast food workers who are asking for $15 an hour (seems crazy now) will be met by $5 a gallon gasoline and at that moment everyone will understand, and the fed will have balanced its monetary policy, somewhat awkwardly.
the take away is that in a normal economy wage pressures would assert themselves and we all move higher. in this case half the nation is on food stamps, and in order for consumers to keep pace the government has to increase benefits. what do you see now? consumer sentiment is in the tank. oil companies are using cash for exploration. Nixon is the last president to use price controls, but controlling interest rates has the same effect assuming interest rates and inflation still correlate, and without wage pressure from workers in the private sector that remains doubtful. government has to provide the COLA and they have spent that money already by blowing past every debt ceiling crisis with more spending.
its going to get ugly and inflation and stagflation and hyperinflation are your three choices
Good points. However, another real probability could be that the deflation scenario isnt just a typiical short term blip on the charts, but it will be more prolonged and unexpected, in part caused by the incidental factor of the never done before QE that created outlier type wage discrepancy, and the destruction of real competitve capitalism, replaced by goverment oligarchies.
Since the true inflation rate is about 8% now, the effective fed funds rate is roughly -8% already! NIRP on steroids.
The economy has been in depression since 2008 (maybe even 2001). Therefore, if the economy goes into recession, that's a huge improvement. Not likely.
At the 20151216 meeting the federal reserve will announce QE4ever, because by then, the economy will be much worse than today, and falling like a rock. Nobody will even imagine higher rates by December 16th.
At which point, even more producers of real assets or real commodities required for a decent standard of living will be thinking long and hard about what we will accept in exchange for the products of our labor. Fuck the motherfucking useless fucking paper pushers already. These fuckers have enriched themselves at the expense of everyone else (again). If it is Global Weimar that they and their political puppets want, so be it.
Fuck em., we are prepared.
Your the ones who deserve the money. NOT THEM. You deserve it because your the ones who actually work for it not them! You have my full support! Their paper is worthless.
Almost 8 billion souls and growing are now inhabiting this biosphere with it's finite resources. If you think any of this eCONomic horseshit is relevant, you are a moron. The oligarchs have been doing whatever the fuck they want for quite a while now. The real cost of anything required for a decent standard of living has been increasing exponentially for quite some time. Sure, you see, short-lived decreases from time to time in certain parts of the world, but eventually all those paper claims on real assets most certainly start to seek them out. At this point, there is no fucking way we avoid global Weimar or WWIII.
Yes, human technology does evolve. Human behavior does NOT.
Very useful analyses.
https://thinkpatriot.wordpress.com/2015/11/11/dynamics-of-national-colla...
https://thinkpatriot.wordpress.com/2015/11/10/a-measure-of-propagandas-p...
The whole basic idea of our systems is flawed. Nothing centralized can work because there is no technology for controlling open, evolving, complex systems. Those are what we inhabit and operate. We can make them work only with a lot of brainpower applied locally. Centralized always fails, and the world has been on a centralization kick ever since politics and war.
https://thinkpatriot.wordpress.com/2015/02/06/high-dimensioned-games/
For the Hasbara trolls:
The Israeli Government does not equal all "jews". Your old scam of using the Holocaust to excuse the behavior of the Israeli Government is worn out. You need a new scam.
You've been here for 40 weeks. You epitomize the new breed of nitwit that has infested this once awesome website. Go fuck yourself, Adolph.
I dont even think its about rates, its about whether stocks and eur/usd corrected low enough for next QE or not yet.