Authored by Mike O'Rourke, Chief Market Strategist at JonesTrading
Ignorance is Bliss
The investment community witnessed financial history on Wednesday. For fifty minutes, Federal Reserve Chairman Jay Powell highlighted the risks to the economy. Specifically, he indicated that there is so much uncertainty to the economic outlook that the Fed’s forecasts in the Summary of Economic Projections are essentially useless. He warned that there are 22-24 million people out of work, and that millions will remain out of work when the economy recovers. He skillfully dodged a couple of questions about asset prices. Finally, with the last question of the day, Bloomberg’s Mike McKee nailed it when he asked the questions on all investors' minds. Essentially, he queried whether the Fed’s response has created a bubble and financial stability risk, and second, whether the Fed has played a role in driving wealth disparity in this country, and last, whether there is a policy tweak that could adjust that trend? The Chairman did not specifically address the second question, but throughout the press conference and his recent speaking engagements, he has stressed that the Fed’s interventions are intended to help the most vulnerable of society. At this point, we are all well aware (and history has proven) that the Fed’s policies to help the vulnerable help the wealthy far more and continue to fuel wealth disparity.
The Chairman of the Federal Reserve’s response to the asset bubble question was stunning and a sign of how far off track the central bank is and what a dangerous environment it is creating. Powell started by noting that once the investment community realized the pandemic was going global, the investor reaction was to sell. He stated “…investors everywhere in the world, for a period of weeks wanted to sell everything that wasn’t cash, or a short term treasury instrument. They did not want to have anything that had any risk at all. And so, what happened, markets stopped working, they stopped working. Companies couldn’t borrow, they couldn’t roll over their debt, people couldn’t borrow. That’s the kind of situation that can be financial turbulence and malfunction, a financial system that’s not working can greatly amplify the negative effects of what was clearly going to be a major economic shock. So what our tools were put to work to do was to restore the markets to function.” Investors selling because of a major negative economic event is the definition of a market functioning properly. He can choose to argue about liquidity in the ten year treasury drying up, but the asset was at record highs. If it had been allowed to correct, liquidity would have returned. Instead, we suspect the Fed Chairman was likely duped by levered long fund managers betting on negative interest rates. When it was apparent negative rates would not materialize, they were trapped until the Fed decided to pay all time highs for hundreds of billions of dollars of Treasuries.
The Chairman then continued, “I think some of that has really happened as I mentioned in my opening remarks, and that’s a good thing. So we are not looking to achieve a particular level of any asset price. What we want is investors to be pricing in risk, like markets are supposed to do. Borrowers are borrowing, lenders are lending, markets to be working.” It appears as though he is saying that because asset prices have rebounded, now markets are functioning. Although the “problem” is resolved, the Fed will continue to keep easing on a daily basis. He elaborated on why the Fed will continue to ease. “If we were to hold back, we would never do this, the idea or just the concept that we would hold back just because we think asset prices are too high, others may not think so but we think that is the case. What would happen to those people what would happen to the people we are actually legally supposed to be serving. We are supposed to be pursuing maximum employment and stable prices, and that’s what we are pursuing.” The reality is that the $8.5 Trillion in stock market wealth created in the last 11 weeks is not creating jobs for any of the 22-24 million unemployed for whom he expressed concern.
Once again, Powell is reinforcing the view that markets that moving higher are functioning and markets that are moving lower are malfunctioning (as he concluded). He stated, “We’re not focused on moving asset prices in a particular direction, or at all. We want markets to be working, and I think partly as a result of what we’ve done they are working and we hope that continues.” The Chairman spent the entire press conference talking about the uncertainty of the recovery, 22-24 million people unemployed, and the millions of people who will remain unemployed. Is that consistent with a market on the cusp of making new all time highs?
The market is more broken today than it was on March 23rd, and it is entirely due to the Central Bank. The most remarkable aspect about Federal Reserve policy over the past 12 years is that very little of it has been related to economics. It has almost entirely been tied to financial markets, and leadership of the Fed over that time has repeatedly exhibited ignorance as to the functioning of financial markets.