Albert Edwards: This Is The Reason Why The Market Doesn't Believe The Fed Any More

Tyler Durden's picture

While it was generally a quiet day in the market, an unexpected tension emerged today: first central banker incubator Goldman Sachs, and then RBC both made the case that Janet Yellen has not only failed to communicate what yesterday's rate hike means, but that the Fed has effectively lose control of the market, by unleashing just the opposite reaction of what the Fed had intended: in fact, as Goldman explained, the response to the market was the equivalent of "almost one full cut in the federal funds rate." In other words, instead of hiking, the market interpreted the Fed's action as a rate cut, which according to Goldman will force the Fed to explain that the market was wrong, prompting even more volatility when the market's inevitable cognitive dissonance hits.

But is it the market's fault it no longer believes the Fed? Of course not, and as SocGen's Albert Edwards notes, it is the "Fed’s lack of verbal assertiveness means the market still cannot bring itself to believe the Fed’s own projections for interest rate hikes."

There are several factors at play here, not only the confusing dots (which as RBC pointed out moved in a hawkish fashion for 2017). As Edwards' co-worker Kit Juckes summed up. "the Fed's reluctance to  send an aggressive tightening signal, instead preferring to again shuffle upwards its dots just slightly, has disappointed markets. But to be fair, the problem isn't really with the famous dots. It's with the market, which just doesn't believe the Fed will tighten as fast as they say they plan to (see left-hand chart below). If the market took the FOMC at their word and discounted a 3% Fed Funds rate at the end of 2019 and beyond, then we'd probably have a 3% nominal 10-year Treasury yield by now."

Kit also points out that after spending the 1980s defeating inflation, the Fed has allowed rates to spend progressively longer and longer below the nominal growth rate of the economy (see right-hand chart above). Trend nominal growth is only a first estimate of where the natural rate of interest might be - and it?s definitely been dragged lower than that in recent year - but depressed market volatility, and the strength of asset prices is a result of low rates. And nominal GDP growth is at 3½% while the FOMC?s range for the dots in 2019 was 3% wide, from 0.9% to 3.9% with a median at 2.9%.?

So how did the Fed become what is essentially a joke to traders, and why does the market no longer believe it any time the message may be a negative one?

One reason why the market doesn't believe the Fed dots is that investors cannot conceive of Fed tightening to the point that it causes the stockmarket any serious damage. Time and time again over both this and previous cycles the Fed has backed off rate hikes as soon as the going got tough. Maybe that is why the S&P trades at such a huge PE premium to the rest of the world?s equity markets (see chart below), for only a small part of this divergence can be attributed to sector composition.


Edwards also notes something that is quite significant from the PE chart above: namely how Japanese forward PEs are roughly the same as where they have been for the last six years whereas the US and the eurozone have seen considerable PE expansion. Yet Japan has seen much more rapid profits growth since the 2008 crisis. Some will put this solely down to the Abe-inspired weak yen, but the domestic-dominated whole economy profits measure shows exactly the same record-breaking profile as the overseas-dominated stockmarket indices.

Just as troubling is that the whole economy profits in the US are not recovering anywhere near as quickly as the stockmarket measures. Indeed it is at this late point in the cycle that US stockmarket non-GAAP, "pro forma" profit measures become increasingly manipulated and detached from the whole economy profit measures.

So what is an alternative metric to look at? According to Edwards, the US whole economy profits measure gives a more ?truthful? representation of companies underlying profit conditions ? the data comes from the IRS and companies don?t tend to lie to the IRS. The whole economy profits data is not so timely as the stockmarket data as the IRS and the Bureau of Economic Analysis have to give the data a good scrub. Hence the Q4 whole economy profits data will only be released with the 3rd estimate of Q4 GDP on 30 March. But a sneak preview is buried deep in the recently released Fed Z1 Flow of Funds release.

What it shows is that very much against expectations, whole economy measures slipped again in Q4 in line with unit labour cost data that show corporate margins are being squeezed. This is in contrast to the heavily massaged stockmarket measures which have been recovering briskly.

As Edwards concludes "we'?ve seen this divergence before at the end of the cycle and I know which I believe. This adds to my concerns that US PE valuations are totally unjustified ? in stark contrast to Japanese PEs."

Ironically, if Edwards is correct about the collapse in profits, then the market is spot on not believing the Fed: after all, the trend confirms a recession is imminent. As such, after 1-2 more rate hikes, the Fed will not only swiftly cut back to zero, or maybe go ECB/SNB/BOJ, but be forced to launch that $1 trillion in fresh QE4 which Deutsche Bank has been quietly expecting for some time.

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BigFatUglyBubble's picture

The market doesn't believe the FED because they know the market will be manipulated to constantly go up.  It has to go up to avoid hyperinflation in the real economy.  There's no brakes on this doo doo brown clown car

Boris Alatovkrap's picture

Car is not brown Doo Doo car but is baby blue Thunderbird drive over cliff, no?

SomethingSomethingDarkSide's picture

Is it still profitable to sell bonds and use the proceeds to buy futures/equities?  You fucking bet.

nope-1004's picture

The key word in your comment was "bet".

#RiggedCasino baby!

Arnold's picture

The Chinks did not substantially devalue the worthless Yuan the last two hikes.
That knife taken away from Granma's throat gives her new will to live.

ebworthen's picture

Exactly.  Rigged Casino.

Why not have the rates at 6% perpetually and let other market forces get to work?

Because they have used jiggering rates to enrich the banksters and punish the citizenry.

That is the whole point of Yo-Yo interest rates; screw the plebeians and reward Wall Street.

Who gets all the "cash" they need at the Treasury window for 4% below market rates 24/7?  Wall Street!

Who gets bailed out when their gambling debts and all other debts go belly up?  Banks/Corporations/Insurers!

max2205's picture

Buy if they if they don't 

Win win 

BrutusTheBomber's picture

I thought Goldman had people in the Fed?.....

besnook's picture

you raise a good point. what if the idea is to use qe to juice the economy while raising rates? to soak up the deflation? they are desperate to get to 3%, at least.

cowdiddly's picture

I actually think this is why the market peformed inverse to the dumb behind the curve cunt yesterday.

. She is badly wanting to unload that 4.3T steaming pile and thinks she can pull it off to get some return and cushion without pile driving everything NIRP.

  The Market is looking ahead through all this. If she keep tapping rates into a contraction then its almost assured that she will have to back up and control/p and the follow-up stagflation.

I think the market is forward looking and sees this. Epic bad timed botch job of the century aka 1934/7

Gigs up babe, they got yer number. She dang sure did'nt scare anybody out with her little rate hike because if your taking away the punch bowl it shoud have had the opposite affect unless its just rigged beyond repair.

I would'nt doubt for the idiot to double down on stupid next time and go .5% in an I'll so you move. They will surely start yammering harder.

Arnold's picture

You talk good sense, Kemosabe.

Dilluminati's picture

Funny thing but there are these pesky things at the IMF called facts.

And what the facts clearly show is debt deflation.

add some modern factors such as naked pricing (where the price is published next to a competitor) such as amazon

Add robotics, add AI, add modern efficiencies in logistics and business processing, and some good old fashioned cronyism, corruption and cabals (think oil cabal) and what you have is a prescription for not religion but facts!

At the end of the day the facts are facts, not there to please you, not there to offend.. only the matter of telling a fact is offensive

It's math, telling you that religion and animal spirits is BS in economics and that math prevails

Listening to Krugman I thought this guy deserves to be stripped of his wealth and put on universal income, as we add more to the rolls of the forgotten we can add the hosts of CNN, MSNBC etc..

these people think religion matters and propose limiting humans to their proposals in economics

Capitalism accepts facts and freedom, accepts math

it is just a fact

there are pesky things called facts and then fairy tales that never pan out

Universal income will work when the poverty in Chicago and Baltimore is fixed.. that is base income illustrated, that is their proposed ghetto

There are some who want to Obamacare the economy, all of it.. and they will be so surprsied when the math doesn't pan out

So Venezuela is it not?

Baronneke's picture

My 2 cents:  Mr Yellen raised rates only to lower them faster than you and I can blink an eye.  The US economy does Not warrant a rate hike......not in a million years.   2017 will probably a very exciting and devastating year. 

Umh's picture

Liars lie. That may be the shortest sentence I have ever written. Oh, it is not. Fuck you. Fuck you is shorter than liars lie.

Back to reality for a second or two. As soon as the FED started yanking the economy around the shit started to smell, umh, about 1913 I'd guess.

orangegeek's picture

When those CB balance sheets get unwound, it's going to be a complete fucking shit show.

Centerist's picture

Everyone loves to lambast the "rigged Wall Street casino", but The Fed is the biggest part of why it actually is fixed.  They put interest rates so low that equities are the only way to get any kind of returns, which inflates a bubble in the stock market.

The artificially high valuations are what are rigged.  The only thing that should drive the market is the real value of the businesses that make it up.  The capricious word of unelected and unaccountable bureaucrats shouldn't.

venturen's picture

negative Yellen is the ultimate prostitute and will do anything for the vampire squid.....She will do anything to get the market up!

timehill's picture

The FED is so much BULLSHIT.  They have been playing the investment public for 8 years now and look where it has gotten them/us!

Can anyone remember when, under President Carter, the residential mortage rates were 18%, commercial 24%, AA-AA munis 12-14% and we have been talking about a measly .25% increase for 8 years!!!!!

Give me a break.

This country is bankrupt; the world is bankrupt with falling GNP all around.  The FED knows it, all Central Banks know it!  How they sleep at night and go out in public making horrendously inaccurate speeches is mindblowing!

Sleep well my friends, sleep well tonight!





Herdee's picture

The old models that they use don't work, they're out of date. Their forward guidance is just another word for propaganda. Does anybody actually believe her bullshit?

absente reo's picture

SocGen's Albert Edwards 

Permanently wrong.

Fucking loser.

rejected's picture

Because there is no Market. 

It's a gamed casino!

Chipped ham's picture

Is my 401k safe? 

GRDguy's picture

The Federal Reserve has just proven that currently all markets (except PMs) are just one giant Ponzi.

PMs are silenced to avoid notifying the public to what is really happening. 

It will all blow up when THEY decide it blows up; not a moment sooner. Just like Madoff.

ds's picture

Another spin from the paradigm of functioning markets. entertaining. it does not take much to understand that deformed markets gyrate under their deformed forces and there is nothing that CBs can do about it. Will you still be preoccupied with CBs that have lost credibilities or profit from it. Just trade the deformities.