Waiting for Jay Powell

We clutch for normality as the next Fed decision point nears.  Will the FOMC raise rates or not?  The media takes comfort from the presence of several trained economists in the room to help poor non-economist Chairman Jay Powell find his way.  We'd prefer an attentive service dog.  But when terms like “confidence” and “credibility” fill the air, just how does being an economist better guide the FOMC? If we are using the tools of the psychologist, how does a close familiarity with statistics and the economists’ version of mathematics help? 

The economist love cult in the world of investments and related media is so overwhelming that there is little actual discussion of the actions of central bankers.  To review, central banks have bought about $10 trillion worth of securities, distorting private markets from stocks to bonds to real estate and commodities.  Credit spreads are extremely tight and recovery rates on many real assets are so good (that is, skewed) as to suggest that credit has no cost.  The markets tremble with expectations of sudden mean reversion.

Former Federal Reserve Board Chairman Ben Bernanke has been on the speaking circuit, taking bows for his great accomplishment of rescuing the world from debt deflation. But now, all of a sudden, Chairman Bernanke is telling us that the wheels are coming off of the proverbial cart in 2020 or about two year’s time.  Is there some connection between Bernanke’s previous acts and this approaching downturn?

The hubris of Chairman Bernanke is monumental as befits a demigod.  All of the immortals who sit in the big room at the big table and guide the monetary machinery seemingly believe themselves to be infallible.  Using imperfect data and even less perfect operative models to guide their actions, the FOMC pretends to be in charge.  But it fact it is the Treasury that is calling the shots in terms of interest rates and the economy.

Our friend Lee Adler has noted with his usual precision that the FOMC is in the midst of the biggest tightening cycle ever, this by simply raising the target rate for Fed Funds and allowing the portfolio to roll off at $20 billion per month.  The FOMC is not even selling bonds, merely not reinvesting.  This runoff is a mere rounding error compared to the funding operations by the Treasury, yet the financial markets remain fascinated with the Fed.

So as the FOMC deliberates and then holds a presser tomorrow, keep in mind that the same forces that have kept interest rates and, more important, credit spreads constrained over these past few years are now holding down returns on bonds as well as volatility.  The $10 trillion in central bank purchases is unhedged and completely passive, thus volatility is constrained. 

With the huge increase in Treasury issuance, spreads should be widening as benchmark rates rise, but instead HY spreads are tightening, long bonds are stable, and the dollar and stocks are soaring.  All of this abnormality, yet we wonder why oh why as the US sucks capital out of the rest of the world to feed our insatiable desire.

As I said, we are clutching for normality in truly strange times.