In Case You Missed It — March 24, 2017

Dear friends,

To say that we live in a brave new world, at least as it pertains to the media, is an understatement. Forget TV and radio as the sole conduits. Since Fed Up’s release five weeks ago, which spans approximately a dog year, I’ve done countless podcasts, Skype radio and video interviews, and Sirius radio stations. I’ve been on channels I’ve never heard of with such deep followings I clearly need to get out more.

Don’t get me wrong, there’s been plenty of traditional live TV and radio interviews. We can just no longer say that’s the norm.

I’ve also written. A lot. And that’s in addition to my weekly, which still stimulates my mind as no other intellectual outlet can.

Manners dictate that I not bombard your inbox every time I opine, in the written word or otherwise. But given the never-ending wrangling to which we are now subjected when our TVs are unmuted, I thought I would share two opinion pieces and one podcast released this week that remind us it is essential to look forward. We can only hope a spirit of compromise prevails giving our leadership in D.C. license to propel the country and economy into forward motion. The Bloomberg piece shot to the top of the most read list so clearly hit nerves. Let’s get going America! (In my humble opinion).

You will see the links to all three below my signature line. Have a great weekend.

Best,

Danielle

It’s Stand and Deliver Time for Trump and Congress on Deregulation — CNBC

Pension Crisis Too Big for Markets to Ignore — Bloomberg

Nine Years Later…All Fed Up — The Bell by Adam Johnson and Tom Essaye Podcast

 

The American Dream: An Endangered Ethos

Few words are slipperier than ‘ethos’ to grasp.

Even the best translation of the word – essence – is hard to get your arms around. Perhaps that is why so many of us were blissfully unaware until recently that the very essence of the American Dream was slipping through our fingers. Though the phrase, which captures the very, yes essence, of the American thirst for adventure, dates back to the hopes and spirit that emboldened prospectors to ‘Go West,’ those who first engaged in California Dreaming, it was James Truslow Adams’ popularization of the term that cemented the ideal into our collective psyche.

“But there has been also the American Dream, that dream of a land in which life should be richer and fuller for every man, with opportunity for each according to his ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order and in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”

It is sweeter still, in the annals of our proud U.S. history that these words were written in 1931, during the thick of the most ravaging economic devastation this country has ever known. And still hope defeated despair, reigning supreme, inviting the lowliest of street urchins to achieve greatness in this country of endless possibilities. Were that only still the case today.

The housing crisis has long stopped commanding headlines. According to ATTOM Data Solutions, the new parent company of RealtyTrac, default notices, scheduled auctions and bank repossessions slid to 933,045 last year, the lowest tally since the 717,522 reported in 2006. Is the final chapter written? Not if you live in judicial foreclosure states such as New York, New Jersey and Florida where ‘legacy’ foreclosures take years to clear. At the end of last year, 55 percent of mortgages in active foreclosure were originated between 2004 and 2008. Factor in what’s still in the pipeline and one in ten circa 2006 homeowners will have lost their homes before it is all said and done.

That helps explain one part of the chart below which was generously shared with me by one Dr. Gates. Longtime readers of these missives will recognize the nom de plume of my inside-industry economic sleuth. His first take on this sad visual, was that, “The heart of the American Dream has stopped beating.” Did that stop your heart as it did my own?

As you can see, after a steady 40-year build, owner-occupied housing has stagnated and sits at the lowest level since 2004. This has sent the homeownership rate crashing to 63.4 percent, the lowest since 1967. It would be nice to think that things were looking up for would-be homeowners. But it’s difficult to be overly optimistic when the local newspaper reports that house flipping in the Dallas-Ft. Worth area rose 21 percent in 2016, seven times the national rate.

In all, 193,000 properties nationwide were flipped for a quick inside-12-months profit last year, a 3.1 increase to a nine-year high. Moreover, the median age of a flipped home rose to a two-decade high of 37 years, about double the median age of homes flipped before the crisis hit. That translated into a median gross profit of $69,624 on a median selling price of $189,900 in 2016, a neat 49.2 percent margin, the highest on record. Awesome!

That is, unless we’re still talking about the American Dream. But then maybe homeownership isn’t all it’s cracked up to be.

At least you can still hang a shingle in this country. Right?

You may note that the decline in self-employed is appreciably more dramatic than the fade among the ranks of owner-occupied homes.

You see, it took more than even the cruelest recession to wipe out two decades of ingenuity, to decimate a trend, to shift a culture. Think of the financial crisis as merely the initial catalyst, the first nail in the coffin.

Then came access to capital, which was dealt a once in a century body blow. Seemingly overnight, credit cards and home equity lines of credit disappeared as a source of operating income. Arguably these two growth governors spread the lack of wealth evenly across the country. But it was the heartland that suffered the most as the number of community banks in the six years ending 2013 sank by 14 percent. Federal Reserve data found that this shrinkage resulted in a 40 percent decline in the number of people with access to community banks. (No, Dr. Bernanke, zero interest rates do not benefit the little guy. They just make it cheaper to borrow for those who have never and never will lose their entree to the credit markets.)

Note that neither ‘Dodd’ nor ‘Frank’ were mentioned in that last paragraph. The awful Act did indeed further impinge access to credit, but let’s say that falls under a different heading, the most insidious of the plagues unleashed on small businesses.

To that end, it’s the last nail in the coffin, the one that’s left behind the most difficult stain to eradicate, as we are beginning to find out the hard way as the GOP tears itself asunder on the public stage. Of course, we speak of the imposition of a regulatory burden that knows no precedent. It’s all but inconceivable to fathom an additional $100 billion in annual regulatory costs but that’s the reality, the legacy of the last administration.

More than anything else, even the Federal Reserve’s assigning of the have’s and have not’s among us, this suffocation of the ability to succeed that raised the hackles of middle-income Americans, bitter that they’ve lost the right to what once was every American’s birthright. The hope is that the nascent rebound off 2014 lows in self-employment continues as red tape is rightly slashed back to where it belongs, that is countries where capitalism doesn’t exist, that the 40-year low in new business formation is squarely in the rearview mirror. The prayer is that recession is not around the corner, an unwelcome development that would undo what little progress has been made.

“My hope is for our current President to turn this tide. Lord knows the last President didn’t do anything to get us back on track, and neither did the Fed,” Dr. Gates observed. “At least we still have baseball, hot dogs and apple pie.”

It goes without saying, ‘tis the season for all three of those National Treasures. Thank you, Dr. Gates.

As for yours truly…shall we dispense with the niceties for just a moment? Like it or not, part of what’s happened in housing is a natural Darwinian outgrowth of the ridiculous zero interest rate policy that’s set profit-seeking scavengers on one another. What we’re witnessing is a mere reflection of a world in which rational investments have been whittled down to nothing.

Still, might we at least raise an eyebrow to the schadenfreude that’s infected the housing market? Should we truly take pride in crowding out those who would rather own than rent a home in the name of hard-to-come-by profits in a low rate world? And what good have we done, allowing our feckless politicians to snuff out a proud history of entrepreneurship that put our country on the map? Will the one percent be capable of lifting all boats, or even care to do so, in order to reestablish our national pride?

It was later in life that James Truslow Adams placed a punctuation mark on his written legacy with the following:

“The American dream, that has lured tens of millions of all nations to our shores in the past century has not been a dream of merely material plenty, though that has doubtlessly counted heavily. It has been much more than that. It has been a dream of being able to grow to fullest development as man and woman, unhampered by the barriers which had slowly been erected in the older civilizations, unrepressed by social orders which had developed for the benefit of classes rather than for the simple human being of any and every class.”

No more elegant words were ever written to ensure our ethos would never be endangered. And yet it is at risk of extinction today. It is high time we stand up for what is rightly ours and take back the American Dream for one and for all.

The Corporate Bond Market: The Start of the Matter

Of all virtues to which we must ultimately aspire, forgiveness demands the most of our souls. In our naivety, we may fancy ourselves man or woman enough to absolve those who have wronged us. But far too often, we find our pool of grace has run dry. So deeply burdened are we by our emotions that grace to us is lost. How many of us have the strength of resolve to let bygones be gone for good? Those of the cloth recognize the damage self-inflicted scars sear into our souls as they seek to guide us through life’s most difficult journeys. They pray for our deliverance from a painful inner turmoil and with it the peace only forgiveness can convey.

None who have ever heard Don Henley’s The Heart of the Matter could be blamed for thinking divine inspiration itself came down from the heavens to spawn those longing lyrics. But it isn’t just the words that scorch their way into your memory, it’s Henley’s tone, the raw pain that pierces every time you’re caught off guard by the mournful ballad released in 1989. Henley sings of our feeble struggle as no other, grasping for our collective release in humility. “The more I know, the less I understand. All the things I thought I’d figured out, I have to learn again.” In the end, Henley hands down the cruelest of convictions: If you truly want to vanquish your demons, you must find the strength within to forgive.

Astute policymakers might be saying a few prayers of their own on fixed income investors’ behalves. The explosion in corporate bond issuance since credit markets unfroze in the aftermath of the financial crisis is nothing short of epic. Some issuers have been emboldened by the cheap cost of credit associated with their sturdy credit ratings. Those with less than stellar credit have been prodded by equally emboldened investors gasping for yield as they would an oasis in a desert. Forgiveness, it would seem, will be required of bond holders, possibly sooner than most of us imagine.

For whatever reason, we remain in a world acutely focused on credit ratings. It’s as if the mortgage market never ballooned to massive proportions and imploded under its own weight. In eerie echoes of the subprime mania, investors indulge on the comfort food of pristine credit ratings despite what’s staring them in the face – a credit market that’s become so obese as to threaten its own cardiac moment. It may take you by surprise, but the U.S. corporate bond market has more than doubled in the space of eight years. Consider that at year end 2008, high yield and investment grade bonds plus leveraged loans equaled $3.5 trillion. Today we’re staring down the barrel of an $8.1 trillion market.

The age-old question is, and remains:  Does size matter?

Ask yourself, did size matter as it pertained to the mortgage market way back in 2006, when it peaked in size at $13 trillion? (That was rhetorical in the event you weren’t on Planet Earth at the advent of all modern times’ meltdowns.) Still, it’s the why behind the growth of any given market that matters most. In the case of both markets, the credit rating agencies have helped investors sleep at night, a fact that might now keep you up at night.

First, a disclaimer. Of course, speculative grade debt is riskier than its investment grade brethren. The vast majority of investors in the go-go junk market know this and are hopefully buckled up as such, especially if a true rate-hiking cycle is about to test their mettle – more on this later.

Still, it’s the blind abandon with which issuance has risen among investment grade (IG) issuers that should, but has yet to, give supposedly conservative investors pause. Consider that in 2011, a (then) record $741 billion was sold into the IG market. As an endless encore, in every single year that followed, issuance has shattered the prior 12-month record. Last year alone witnessed $1.28 trillion in issuance. As for all the rate hike anxiety permeating the airwaves, 2017 also appears to be in it to win it — $254 billion was sold in the first two months of the year, $20 billion more than the same period in 2016. Investors might soon have to call upon Archimedes’ concept of exponentiation to sufficiently capture how very large the numbers have become.

You might wonder how the health of the corporate bond market is faring as it bulks up. As Bloomberg reported last week, you’d have to time travel back to 2002 to get back to the last time IG issuers were carrying more debt vis-à-vis their profits. The sticking point is leverage ratios tend to peak as an economy is just emerging from recession, as companies’ revenue streams hit their nadir.

Today, though, as we’ve been told in tsk-tsk fashion, the economy is at the precipice of an accelerating trend. That’s a good thing as companies have sold a heck of a lot more debt than their profit growth justifies, leaving their rainy-day cash to cover their massive, mounting obligations at the lowest levels since 2009.

The good news is that on the surface, the chances of a hiccup appear to have diminished. According to credit rating agency Standard & Poor’s (S&P), 2016 ended on a relatively better low note: Some 68 global IG issuers were at risk of being downgraded speculative grade, five fewer than the last time the data were compiled at the end of the third quarter.

S&P refers to these envelope-pushing issuers as ‘potential fallen angels,’ with ratings at the cusp of crossing over into junk-land. Though you might be thinking one notch on a ratings scale is just that – one measly notch – crossing that line in the sand makes a huge difference for borrowing costs. The yield ‘spread’ above Treasuries paid by junk issuers is typically about double that of what IG issuers pay.

The not so good news is that the universe of potential fallen angels remains at historically high levels. The latest read of 68 potential fallen angels is identical to what it was last summer and appreciably higher than as recently as 2015’s first quarter when 42 issuers were at risk of downgrade to spec grade. Moreover, the divide that began to open between potential rising stars – those with the potential to be upgraded into the IG sphere – and potential fallen angels remains at the current cycle’s wides.

Perhaps most worrisome is the sector at the greatest risk of downgrades — that is, financials. Years ago, a high yield strategist remarked that declining commodities prices would take their toll in two waves – first, the actual commodities producers, and second, the financials who banked them as the initial commodities cycle became super-sized in magnitude. Bank balance sheets are highly susceptible to a nasty contagion effect.

And yet, here we sit watching those oil prices Janet Yellen lectured us would be at ‘transitory’ lows (several years ago) decline anew. God help us if crude’s latest swoon presages a broader downturn. Precisely because leverage is rising among IG borrowers, economic growth literally has to hang in there. If growth even slows, or worse, contracts, all this ballyhooed record issuance among IG issuers will devolve into unprecedented levels of potential-to-actual fallen angels. It will be as if the heavens have opened up as their wings burn and they tumble back to earth.

Of course, downgrades don’t necessarily denote defaults. The Start of the Matter may nevertheless require forgiveness in some form as refinancing needs are also now at record levels and must be met. If the Federal Reserve does not intervene, markets are likely to revert back to pure price discovery mechanisms; they will be brutally agnostic to the rate environment to say nothing of the economic backdrop.

Investors have begun to smell a rat. IG exchange-traded funds (ETFs) have slid more in price compared to their high yield ETF peers since the surprise U.S. election that set rates rising. But unlike junk’s magnificent rebound since then, IG has yet to stage a return rebound.

It all comes down to refinancing risk. According to S&P’s competition down the block, Moody’s, the refinancing needs of both IG and spec grade issuers will hit record levels over the next five years.

Spec grade issuers’ five-years-out refinancing needs have officially crossed the trillion-dollar threshold. Some $1.06 trillion will come due between now and 2021, up from $947 billion in last year’s refinancing risk study and double what they were ten years ago. In the event you’re concerned spec risk has been overly downplayed in this missive, rest assured, the same dynamics that propel record fallen angel levels will be the mother of all default-rate cycle accelerants. File that one away in the ‘actual forgiveness’ to come file.

As for the IG space, $944 billion comes due in the five years through 2021. But here’s the kicker – the need to roll over debt is going to come on much more quickly for IG. Maturities are roughly evenly distributed over the next five years as opposed to the needs in spec grade, whose rollover risk gains speed and crescendos in 2021 with a record $402 billion in refinancing coming due.

Is that why junk is trading more richly than IG? The yield at which spec trades vs. its Treasury equivalent has only been wider 13 percent of the time over the past 17 years (2007 should provide you comfort because…?). IG on the other hand has traded this ‘tightly’ in only 25 percent of the times records have been kept.

Would the start of the matter – the prospects for debt forgiveness and debilitating defaults – be threatening so were it not for central bankers’ meddling ways in markets designed to determine their own damn prices? The ashes will indeed scatter. They will let us know.

The Buford T. Justice Job Market

The Buford T. Justice Job Market, Danielle DiMartino Booth, Money Strong, Fed UpNever in the history of filmmaking has artistic license paid off so handsomely.

Of course, comic legend Jackie Gleason was no schlep in the world of thespians. Odds were high he would deliver a handsome return on stuntman cum director Hal Needham’s investment. And while it’s no secret there would have been no directorial debut for Needham had his close friend Burt Reynolds not agreed to be in the film, it was Gleason’s improvisation that made the Smokey and the Bandit the stuff of legends.

Though Gleason’s character’s name screams ‘surreal,’ the stranger than fiction fact is that Reynolds’ father was the real life Chief of Police in Jupiter, Florida who just so happened to know a Florida patrolman by the name of Buford T. Justice. The treasure trove of quotes from the film’s tenacious Texas Sherriff Buford T. Justice, who so tirelessly pursues the Bandit in heedless abandon over state lines, elicited nothing short of laugh-out-loud elation from anyone and everyone who has ever feasted on the 1977 runaway hit (it was the year’s second-highest grossing film after Star Wars).

Gleason’s most famous ad-lib moment occurs at a roadside choke-n-puke where Justice unwittingly strikes up a conversation with the same Bandit he’s chasing. “Let me have a diablo sandwich, a Dr. Pepper, and make it quick. I’m in a goddamn hurry,” Justice barks at a waitress after which point he explains to an innocent-faced Reynolds that he’s in such a hurry because he’s chasing a ‘maniac.’ As for yours truly’s favorite, there’s simply nothing funnier than Justice’s rant to his witless son: “There’s no way, no way, that you came from my loins. Soon as I get home, first thing I’m gonna do is punch yo mamma in da mouth.”

As much as Justice wants to score one for the good guys — “What we have here is a complete lack of respect for the law” — in the end, the ‘bad guy’ eludes capture. By the time the credits roll, the audience has no choice but to feel a little sorry for Justice and his habit of acting, and speaking, before he thinks, which inevitably leads to his downfall.

Far from 1977, a new sheriff is in town, and a certain White House occupant is in equally hot pursuit of, not a Bandit, but a strong job market to indelibly leave his mark on history. For the moment, it looks like he’s going to get exactly what he’s asking for using brutish Buford T. Justice-style tweets. At least that’s the causality guaranteed to be drawn.

Something is for certain. The job market is not behaving as one would expect in an economic recovery that’s nearing its eight-year anniversary. And it’s not just one aberrant indicator we’re talking about here.

Forget that we’ve just enjoyed one of the mildest winters on record. The 106,000 goods-producing jobs created in February is officially one for ADP’s record books in data that stretches back to 2002. In all, companies added 298,000, the most in nearly three years. This report alone will quickly silence all the whining we’ve heard of late about soft data being stronger than hard data.

As ‘soft’ as the survey data may be, one indicator within the most recent ISM report is plenty hard. Care of one of the buyside’s best and brightest, whose name has to remain outside the public purview, ISM customers’ inventories at a 10-month low necessitate a period of catch-up on companies’ parts.

A quick primer: The ISM report is a composite index of five diffusion indexes – employment, production, inventories, new orders and supplier deliveries – gathered from surveying over 300 manufacturing firms. A reading of greater than 50 signals those at the forefront of a company’s supply chain anticipate accelerating economic activity; a sub-50 reading signals the opposite. A reading of 65 or higher on the most forward-looking ISM new orders index pushes manufacturing into technical ‘bubble’ territory. As for 70, if it’s reached, look out below as the economy will have officially overheated. The most recent two episodes of 70 being hit occurred before most of us can remember, in 1973 and 1983. The pullback in activity that followed was, shall we say, swift and not so neat.

The current 65-reading on the ISM new orders sub-index, coupled with depleted stockpiles, indicate economic activity could well boil over. Companies will try to get ahead of tight supplies by paying up; delivery times should rise alongside this impulsiveness. Surprise, surprise — the sell side will feed the frenzy, which will push purchasing managers to go one step further and pile on supplies in anticipation of future demand.

Inventory builds, you will recall from Econ 101, are GDP-friendly. So set aside the Atlanta Fed’s Debbie Downer first-quarter GDP forecast of a paltry 1.3 percent. The second quarter looks set to stage a raging comeback. And it looks to be widespread. Of the 18 industries surveyed by the ISM last month, 17 reported improving conditions, up from just 12 in January.

But here’s the catch (does there always have to be one?). This from the ISM: “Comments from the panel largely indicate strong sales and demand, and reflect a positive view of business conditions (but) with a watchful eye on commodities and the potential for inflation.”

In other words, firms are a wee bit concerned a margin squeeze is on the horizon. If that’s the case and the job market is gaining momentum, they should add tightening financial conditions to their worry list.

Pop back into that econ class for a moment. The unemployment rate is the most lagging of all indicators. That means Fed officials should be hard-wired to underreact to job market data. What’s more likely is that they will be compelled to play a bit of catch-up of their own, chasing the curve they’re woefully behind with all their might.

Look no further than the follow through in the bond market from the blowout ADP report. At 1.36 percent, the two-year Treasury note yield is near an eight-year high, which has grabbed investors’ attention by the short hairs. Meanwhile, back over at the Bloomberg Terminal, the following headline just crossed: “Jobs Data May Fuel Bets on Four Rate Hikes in 2017.” Three hikes are darn near baked into the cake, as in a one-handle on the fed funds rate by September. Imagine that.

Like it or not, the Fed’s chase is likely to end just as badly as Buford T. Justice’s did.

Crash landings tend to follow the unemployment rate when it overshoots to the downside, which is exactly what households suggest is in the offing. The last time this many folks were predicting the unemployment rate would be lower 12 months hence was the early 1980s. What followed? Not just overheating, but a 10 percent correction in the S&P 500 over those same next 12 months.

What if, just maybe, just sayin….these extreme readings indicate that firms are sticking like glue to their employees out of a sense of panic that they’re irreplaceable in a world bereft of sufficient skill setters? What if the true, underlying job market is not gaining strength.

That would certainly seem to be the case in the message delivered via gauntlet in the Conference Board’s latest online help wanted postings. Before the howls of, “One month never makes for a trend!” begins, bear in mind that new job postings peaked in November 2015 while those of re-postings (new net of old) peaked a month later.

Up until this latest data set from February, the decline in demand for new employees had been steady but orderly. All that changed last month with the record 364,000 decline in new help wanted ads. The only month that was anywhere near as ugly was January 2009 in the thick of the last recession. Not only that, all 50 states saw declines as did all 52 metro areas tracked.

The one-month move was so striking the Conference Board released the following note with its report: “Recently, the HWOL (Help Wanted Online) Data Series has experienced a declining trend in the number of online job ads that may not reflect broader trends in the U.S. labor market. Based on changes in how job postings appear online, The Conference Board is reviewing its HWOL methodology to ensure accuracy and alignment with market trends.”

You gotta give the number crunchers credit where it’s due – at least they admit to their potential fallibility. That’s more than can be said of the arbiters of the inflation data favored by Fed officials.

We will soon enough know if all this inventory building meets a happy ending. If today’s reported demand is still red hot come Labor Day, well then, the labor market’s current signals could bode well for one Donald J. Trump’s first year in office.

If that’s not the case, if this is a massive head fake, well then manufacturers could be warily eyeing bloated stockpiles come August, stockpiles built on hope. Those keeping the nation’s factories up and humming might even be disenchanted enough to strike out against Trump’s attempts to jawbone the U.S. manufacturing sector back to its halcyon days. The exchange that follows could echo the following from Smokey and the Bandit, one that took place between a peeved fellow sheriff and Sheriff Justice, who had crossed uninvited into the other’s jurisdiction:

U.S. Manufacturers: The fact that you are President is not germane to the situation.

DJT (in a tweet): The goddamn Germans got nothin’ to do with it!

Oh, and please pardon the slight artistic license taken with the cast of characters. Think you get the message about what can be lost in translation loud and clear.

The Five-Tool Bond Market

The Five-Tool Bond Market, Danielle DiMartino Booth, Money STrongWillie Mays, Duke Snider and Ken Griffey, Jr.

It’s no secret that these bigger than life baseball players are all Hall of Fame legends. But what about Mike Trout of the Los Angeles Angels? Or the Pittsburg Pirates’ Andrew McCutchen or Carlos Gomez of the Texas Rangers? What do all six of these greats have in common?

If you guessed that none of them were pitchers, you would definitely be on to something. If you’ve really been doing your homework in the preseason, you would patiently explain that all six were “complete ballplayers,” with above-average capabilities in hitting, hitting for power, fielding, throwing and running. If you wanted to show off, you could elaborate that each has at least three qualified recorded data points in one season in each of the five areas rendering them “five-tool players.” These are the well-rounded players of field scouts’ dreams.

The idea of this quintessential, albeit exceedingly rare player, harkens to another picture of perfection – the bond market. After peaking above 15 percent in 1981, the yield on the benchmark 10-year U.S. Treasury fell in July of last year to a record low of 1.36 percent. That there is what we call the rally of a lifetime. A major contributor to the mountains of wealth that bonds have generated include the venerable inflation-fighting of one Paul Volcker. The three subsequent boom and bust cycles, largely engineered by Volcker’s successors at the Federal Reserve, each made their own contribution and brought greater and greater degrees of intervention to bear on the market and helped push yields lower and lower. In bondland, that translates to prices soaring higher and higher.

Over the years, the castigators were cast aside time and again. As for the few with steel constitutions, who quickly drew parallels between Japan’s intrusions and those of the Federal Reserve, let’s just say they can retire and rest in peace. They bought 30-year Treasury Strips and buried them, giving new meaning to the beauty of buy and hold. To keep the analogy alive, let’s say that at that juncture, the bond market was a four-tool player.

But then suddenly, last summer, something gave way.

Since July, the conventional wisdom has held that bond yields have finally troughed, bringing a denouement to the 35-year bull run. Of course, those comprising the consensus collided in arriving at their conclusions.

Market technicians, aka the chart-meisters, provide the simplest explanation. In 2016, the 10-year yield sunk below 2015’s low of 1.64 percent and rose above its high of 2.50 percent. Technicians refer to such boomerang behavior in short spaces of time as “outside events” that mark the beginning of the end of a cycle.

The reflationists point to the pronounced uptick in the industrial metals complex as proof positive that inflation has seen its lows of the cycle. Everything from nickel to rebar to copper and back validated the notion that pipeline and margin pressures were building, especially if you had building a pipeline in mind.

And then we have the bullish economist cabal who insist that gross domestic product is set to accelerate into some sublimely sustainable hyper-drive mode. The increase off the lows in interest rates purely reflects the markets being forward-looking mechanisms and sniffing out the bevy of incendiary economic accelerants. In the event you’ve just emerged from a medically induced coma, we’re talking about small business formation, tax cuts galore and repairing every crumbling bridge and filling every pothole from Bangor to Baja. Oh, and by the way, delivered care of our cuddly Congress, in full, tomorrow.

Lastly, there’s the camp with which yours truly would most likely be associated: The Skeptics. As the ridiculous veered into the surreal last year, as nearly a quarter of a trillion in global debt yielded from somewhere south of one percent into deeply negative territory, some of us skeptics began to ask the ye-of-great-faith-in-omnipotent-central-bankers if they grasped the implications of policymakers’ intrusions. Did they really believe Mario Draghi could vacuum up a corporate bond market lock, stock and barrel, and his counterpart Hiroki Kuroda an entire stock market and live to tell? Or was exhaustion overcoming exertion?

At the end of the trading day, all four camps’ arguments are moot. At least, that’s the message the 10-year Treasury is communicating in no uncertain terms. If there is one thing the 10-year can be called upon to deliver, it’s consistency, as in behaving in the same way over time so as to be fair and accurate in anticipating the future. Lest you etymologists, pundits and, dare say, traders in our midst be tripped up, try not to confuse consistency with what you believe to be predictability, as in behaving in an expected manner.

You can carry this much, though not all the way to the bank — the bond market should have corrected long ago if history was any judge. Inflation, heck hyperinflation, should have ignited and burned our currency to the ground by now. But that hasn’t happened, has it? Unlike so many of you who do indeed deliver on the expectations front (yawn), the bond market has consistently surprised those with cocky certitude calling for sea changes.

You’re forgiven if it’s been difficult to incorporate a once-in-a-century outlier factor into your decision-making framework. The entrant of over a billion workers into the global workforce, coupled with the building out of the equivalent of the United States in its glorious industrial age, introduced a deflationary impetus that simply doesn’t exist in any economics textbook in print today. The weighty subsequent suppressant on yields, combined with the artificiality of central banks butting their way into bond pricing, held rates lower than logic or any econometric models dictated, confounding the esteemed doctorate community.

As for the here and now, worry thee not about the chartists, the inflation worrywarts, the optimists and even the skeptics. The decline in the 10-year yield tells you everything you need to know, and probably more than you’d like to acknowledge.

The simple fact is, the current economic recovery has peaked and rolled over. It’s one thing if some subprime auto lender you’ve never heard of is whining about regulators clamping down on premature repossessions. It’s quite another when the data tell you that car inventories are up nearly 10 percent over last year, GM is choking on incentives of its hottest selling pickups and State Farm has just swallowed $7 billion in auto loan underwriting losses (gulp!). Last check these were not hot-money, private-equity-backed fly-by-nighters.

In the event you require yet more proof that the bond scare was just that – scary — Behold! The yield curve flattens! After hitting a wide of 136 hundredths-of-a-percentage-point (basis point) in mid-December – which just so coincided with global bond losses hitting a cool $3 trillion — the difference between the 2-year and 10-year Treasury has narrowed to 112 basis points. Finance 101 tells us that the slimmer the divide between short and long rates, the closer we are to crossing into the netherworld, otherwise known as recession.

This precarious position posits a pondering pause:  Exactly where does the Fed fit into the equation? By the looks of things, the post-election Fed has morphed into its answer to Dirty Harry. Odds of a March rate increase have catapulted to 70 percent in the space of three trading days, a tidy trek for academics more apt to move at the pace of molasses in January. And yet, their tough talk is borderline brash.

Take this from New York Fed President William Dudley three whole days before the onset of the blackout period ahead of next week’s Federal Open Market Committee Meeting begins: “I just think it makes the risks to the outlook a little bit tilted to the upside at this point.” When further queried whether the next rate hike should come, ‘sooner rather than later,’ Dudley replied. “I think that’s fair.”

As benign as his comments may read, make no mistake, they’re fighting words for a Fed that’s given new meaning to skittish for the better part of three decades. It’s as if Fed officials were contenders within reach of that five-tool status save one that last qualifier – hitting for power with a home run distance of 425 feet or more. Recall that Dudley is Vice Chairman of the Federal Open Market Committee. In other words, his conceding to a ‘go’ in March cleared the ball way over the fences.

Rather than delve into any (deeply political so as to throw economy into recession) motivations, let’s look beyond the next recession, inadvertently induced by an overly aggressive Fed, to the next question: How do policymakers wage that next battle?

Since you ask, this is where baseball reenters the equation, in its positively perfect form, in all its five-tool glory. Fighting the next recession is theoretically where the academics shine brightest and hit their collective pleasure threshold. This is where the bond yields steal home. There’s one word for it. Wait for it… “MONETIZATION.” The debt doth disappeareth.

It wasn’t until a recent and very heated public debate, at which a friendly colleague attempted to put your fearless writer in her place (a mistake), that the height of the stakes became apparent. For starters, we both agreed that the overabundance of debt, not just in the United States, but globally, was problematic. Fair enough. The solution to such an intractable problem was thus by its very definition, tricky bordering on tempestuous.

The good news, he insisted, was that in the end, boys would be boys and men would be men. The overly indebted developed-world economies would march off into the great blue yonder and not return until a gentlemen’s agreement has been secured. Pray tell, what form would that take?

In short, not in the neatest of forms. A blanket propaganda campaign would have to be launched educating the clueless public about the virtues of negative interest rates and a cashless society. Upon that sturdy foundation, we could then construct a full-blown monetization of the bloated debt we carry today, one in the same with what we’re told is technically irrelevant because models dictate it can be wished away.

Lest you be led astray, there’s no cathartic Kumbaya that conveniently follows before the credits roll. Milton Friedman was, and remains to this day, spot on in his observation that there is no such thing as a free lunch. My undaunted debater conceded that there would be losers, mainly emerging nations shouldered with boatloads of dollar-denominated debt and developed nations that were naïve enough to not be burdened with excessive debts. But so be it.

In global credit markets that exceed $200 trillion in outstanding securities, dominated by dollar-denominated debt, I deign to accede that the losers have much to lose indeed. Whether they will take their lumps lying down like lambs, however, remains a much wider, open and heated debate than that which played out on a stage in Austin, Texas. My greatest fear is that the war we will eventually face is of the all-too-real variety, precipitated by the greatest income divide since the years that preceded the Great Depression and the Second World War.

Rather than focus on such dire potential outcomes, take comfort in the adage that history doesn’t precisely repeat itself, but rather merely rhymes. Between now and Sunday, April 2nd, baseball’s opening day, relish in the welcome distraction to come. Count your blessings as we count down to the day we hear, “Play Ball!” and spectate with hope for the next five-tool player to make us once again believe.

UpEnding the Fed: The Administration Redemption

Danielle Dimartino Booth, Money Strong, The Administration Redemption“Remember Red, hope is a good thing, maybe the best of things, and no good thing ever dies.” 

Wiser words were never spoken on the big screen than those of The Shawshank Redemption’s main character Andy Dufrense. We are none of us beyond redemption, so we are taught by this banker from Maine, even when we are punished for crimes we did not commit. In briefly researching the movie, one comes to learn that it is based on Stephen King’s 1982 novella Rita Hayworth and Shawshank Redemption. No doubt, Hayworth’s role in the movie stands out in all our minds, which is saying something as the superstar was no longer with us.

Dig deeper and you learn that King’s longer than a short story, but shorter than a novel, was part of a series called, Different Seasons, subtitled Hope Springs Eternal. How reassuring if enigmatic. More perplexing still is this master of the horror genre’s inspiration — Leo Tolstoy’s God Sees the Truth, But Waits. It would seem that Carrie has met Anna Karenina.

Clearly, it’s easier to judge those who write books by their most famous covers. But why not set such preconceived notions aside. You too can bask in King’s gorgeous prose from Shawshank and even Tolstoy’s beautiful words of inspiration: “If you want to be happy, be.” And redemption: “Everyone thinks of changing the world, but no one thinks of changing himself.”

These words resonate so against the backdrop of a country that remains intent on fomenting division, on splitting itself at the seams, bent on self-destruction. Perhaps it will have to come down to one man and his ability to change himself, to draw in more than his avid followers but his doubters as well.

For yours truly, it has thus been curious, nay fascinating that on matters of the Federal Reserve one Donald J. Trump has been silent as a mouse whose paws cannot bang out 140-character rants. Perhaps, just maybe, he is busy doing late night reading on the foundations of this venerable institution. If that’s the case, maybe he came across this little gem that was passed along recently:

“In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.”

Maybe that’s why the media has begun to dispense with the labels “hawk” and “dove” and is beginning to replace the aviary with simple human beings who have been there and done that, who have been on the receiving end of Fed policy for their entire careers. Take this from Kate Davidson at the Wall Street Journal:

“After his campaign criticism of the central bank’s low-interest-rate policies, many observers speculated he would seek more “hawkish” candidates who would favor higher borrowing costs. But his choices may be driven less by these issues and more by their practical experience, judging from his early picks for other top economic policy posts in the administration—drawn from investment banking, private equity and business—and the pool of early contenders for the Fed jobs.” 

Meanwhile, the Financial Times’ Gavyn Davies had this to say:

“The last four Fed Chairs have all been clearly on the economist side of the line, and because they have all bought into the Fed’s economic orthodoxy, their actions have been considered somewhat predictable by the markets. A business person or banker might be less predictable, at least initially, and more prone to shake up the Fed’s orthodoxies, for good or ill.”

With deference to Mr. Davies, there can be no ‘for ill’ in shaking up the Fed’s orthodoxies, if you can call them that. Orthodoxy, from the Greek word orthodoxia, implies officials are cleaving to a correct creed. But what if policymaking has devolved from correct to simply accepted?

That would imply a good dose of heterodoxy, also Greek from heterodoxos, was in order, as in a departure from the official position. To be crystal clear, heterodoxy does not equate to heretical, from the Greek hairetikos, (pardon the digression but who gave the Greeks a monopoly on multisyllabic, cool words?). Even so, a bit of heresy would also do the Fed a world of wonders. The literal Greek translation means ‘able to choose.’

A recent study determined the study of economics in academia had itself become incestuous with a great preponderance of students being trained in the same school of thought. This determination was not only disturbing and dangerous, it demands politicians introduce a bit of heresy into our nation’s central bank.

Perhaps President Trump, his administration and all members of Congress should sit down for a tutorial on Heterodox Economics (nope, not making that one up), which refers to schools of economic thought which fall outside of mainstream — read Keynesian – economics, which is predictably referred to as orthodox economics. Maybe, just maybe, it’s high time a variety of schools are incorporated, as in the post-Keynesian, Georgist, social, behavioral and dare say, Austrian approaches.

That last one, the Von Mises-inspired Austrian school of economics is apparently public enemy number one. The FT’s Davies goes on to warn that some candidates up for those open and opening positions on the Fed’s Board of Governors are ‘Austrian’ economists, a school that has apparently influenced Vice President Pence. An “Austrian” candidate would certainly alarm the markets.”

Davies has apparently done his homework. Back in 2010, one Mike Pence was serving in Congress as a representative of Indiana. In response to the Fed’s insistence on launching a second round of asset purchases, which the markets adoringly embraced as QE2, he blasted back that, “Printing money is no substitute for pro-growth fiscal policy.”

Pence’s words certainly ring Austrian, as the school considers malinvestment to be a menace, as well any rational person would. Malinvestment (we can finally score one for the Latins!) is defined as a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses.

And we wonder why we’ve had such a long run of jobless recoveries that happens to coincide with the post-Greenspan era. Why would the markets abhor an Austrian? Clearly, we would not have starved productivity by overbuilding residential real estate in the years prior to the crisis. Nor would companies have gorged on record share buybacks in the years that followed. Agreed, these phenomena juiced returns. But to what end aside from protecting the legacy of the mythological ‘wealth effect’?

As my dear friend Peter Boockvar wrote of the wealth effect in response to the Fed’s meeting minutes from its January meeting: “The concept, invented by Alan Greenspan, and carried on by Mr. Bernanke and Mrs. Yellen, is the unspoken third mandate of the Fed. Well Fed, you certainly got what you wanted in terms of a dramatic rise in asset prices over the past 8 years (just look at the value of equities relative to the underlying US economy) but a wealth effect did not happen if the pace of personal spending in this expansion is any indication. For many, it’s the wages they earn and the savings they keep that drive spending decisions, not the value of their stock portfolios.”

For taxpayers’ money, because they will pay in the end, it would seem we need Peter to fill one of those vacancies on the Fed’s Board. Just sayin’. Would the man who coined the term, ‘monetary constipation’ to describe the, “constant hemming and hawing over a rate hike…even in the face of a world that clearly changed on November 8th  and as we approach the 8th  year of this expansion.”

President Trump, can you hear Peter?? This is not the time to be obtuse. This is the time to bring back the good things in life, beginning with the best – hope. Dig as deep as you can and ask yourself some probing questions. Can you stand up to the orthodoxy that’s robbed the business cycle of its very cyclicality? Are you man enough to populate the Fed with leaders who are so strong there’s no need to audit the out-of-control institution? Pray God, does Mike Pence have your ear? You may be a debt kind of a guy, you’ve said so yourself. But you’re also beholden to no one and have a once-in-a-century opportunity to reshape the world’s most powerful central bank and in doing so safeguard the sanctity of the U.S. dollar.

As Andy Dufrense explained to us all, “I guess it comes down to a simple choice, really. Get busy living or get busy dying.” It’s time we got back to the business of living in this country, every single one of us. Who are we to question if it takes a heretic to get us back to where we need to be?

In Case You Missed It

In Case You Missed It, Danielle DiMartino Booth, Money Strong, Fed UpDear friends,

These past two weeks rank among some of the most tumultuous in U.S. postwar history, not just for investors, but every group imaginable save young children who’ve the freedom to not pay attention, much less care. ‘Uncertainty’ has taken on new meaning as the news cycle contracts to a nano-range in which sentiment can turn in the space of a 140-charcater transmittal of an unexpected message.

Into this breach stepped the Federal Reserve on Wednesday. Rather than capitalize on the uncertainty of the moment, policymakers retained their relatively cautious stance, wasting the chance to prepare markets for 2017 being the most aggressive year of tightening in over a decade. Recall that there are but four FOMC meetings followed by a press conference. If FedSpeak can’t jawbone a March rate hike back onto the table, policymakers will have precious little room for error to make good on their promised three rate increases for the remainder of the year.

Of course, ‘data dependent’ remains the mantra. Following Wednesday’s ADP report, and despite the data’s unreliable predictive power, confidence in today’s January labor report skyrocketed. This echoed household’s healthiest prospects for the job market since Reagan was in office. That makes it a good thing headline job growth did not disappoint. Private job creation exceeded estimates by a healthy margin, coming in at 237,000, 62,000 more than expected. Meanwhile the unemployment rate ticked up for the right reason, as more able-bodied workers rejoined the labor force.

The one black eye in the report was wage growth. At 2.5 percent in the 12 months through January, average hourly earnings ticked down from December’s 2.6-percent rate. That’s something of a surprise given the minimum wage rose in 19 states at the start of the year. Add to this what Peter Boockvar pointed out – that 305,000 jobs were lost by those in the 25-54-year cohort. Those ‘prime earning years’ have just not delivered for far too many in the current recovery. Strong wage gains remain the missing link, a subject I will write about in the coming week.

As for the trading week we’re about to log into the history books, it was a very busy one for yours truly in chilly New York. I’ve pasted links to what you might have missed below. As always, your feedback is most appreciated.

With that, wishing you the best for a relaxing weekend. To capture that peace, you might want to pretend we’re back in medieval times and not being endlessly pinged. In other words, unplug, lest you’re constantly jolted back to the new news cycle and our collective newfound restlessness.

All best,

Danielle

Click through:

Debt and Deficits Are About to Matter Again for Investors — Bloomberg  

The Federal Reserve Has Squandered an Opportunity – CNBC 

Live Reaction to Release of Fed Statement — CNBC 

Federal Reserve Policy: The Cash Menagerie

Danielle DiMartino Booth, Money Strong, Fed Up, Cash Menagerie, Newsletter“Yes, I have tricks in my pocket, I have things up my sleeve. But I am the opposite of a stage magician. He gives you the illusion that has the appearance of truth. I give you truth in the pleasant disguise of illusion.” 

The next time you happen to find yourself at 111 West 44th Street in New York’s theater district, make it a point to gaze up at the haunting image of the illuminated sign for The Glass Menagerie, the play that launched the career of America’s greatest playwright. Maybe you too will recall the unsettling opening lines written in 1944 by Tennessee Williams, spoken by his protagonist, Tom Wingfield. Tom’s words promised to deliver the sort of truths few of us covet, though the play’s entertainment value has clearly withstood the test of time.

If you’re of the rip-the-Band-aid-off philosophy on facing life’s unpleasant realities, pivot on your heel and look across the street, to 110 West 44th Street. Your eyes will be immediately drawn to the less mesmerizing, but equally inescapable, signage gracing the edifice of that building, the U.S. debt clock, that live, unrelenting tally that is marching towards $20 trillion, be we all damned.

One must wonder if Broadway’s denizens see the theater in having these two facades stare one another down, as if taunting the other to wax more fatalistic.

This week, Federal Reserve policymakers will release a policy statement that paints an illusion of prosperity in cold monetarist verbiage that feigns the appearance of truth. The doves’ message will be uncharacteristically hawkish. They will flap their wings about accelerating underlying growth and inflation. They will allude to the time being upon us to normalize interest rates, to come in from a long, brutal winter of artifice.

The truth, you ask? Unconventional monetary policy in the form of zero interest rates and quantitative easing braced an economy that has been and remains fragile. And yet, as evidenced by the most recent bout of euphoria, animal spirits are out in full force.

There are other calendar years ending in the number ‘7’ associated with rampant speculation in asset markets and a strong Fed. Only one of the two proved to be a buying opportunity. The other stands as testament to one of the greatest monetary policy blunders in history.

As was the case in 1936, monetary policy had been manipulated to serve political needs. It’s noteworthy that the form assumed differed from that of recent years: it was huge gold inflows that were being monetized back then, but similarly, interest rates had been held closer to the zero lower bound for a protracted period.

In another parallel, measured goods inflation was conspicuous in its inability to achieve liftoff while that of asset prices was off the charts. (Has it really been 80 years of repeating the same mistake in gauging aggregate price behavior?) Then and now, investors exiled to a yield dessert justified their irrational approach to investing by rhetorically asking, “What’s the alternative?”

Commodities and stocks were the primary target of speculators in the recovery that took hold in 1933. Today, commercial real estate (CRE) and bonds have taken center stage while that of stocks is running a close third depending on your preferred valuation metric.

The latest Moody’s/RCA CPPI aggregate price index for CRE is remarkable. Prices through November, the latest on offer, are up nine percent over the past year. But they are perched 23 percent above their pre-crisis peak, which represents a vertigo-inducing 159 percent recovery of prices’ peak-to-trough losses. Morgan Stanley’s Richard Hill and Jerry Chen helpfully provide perspective on this figure: residential real estate, by comparison, has recovered a mere 80 percent of its losses. As for what’s driving the CRE train, office and industrial properties have taken the lead while, no shock here, retail property prices have begun to decline.

As was the case throughout the housing mania, loose underwriting standards can be credited with initially pushing prices upwards. Add to this lender behavior. Smaller banks, in particular, have aggressively reduced fees to garner market share, raising the ire of Fed regulators alarmed at the growing concentration of banks’ exposure to CRE loans. At last check, banks accounted for nearly half of CRE lending activity, up from 35 percent a few years ago. The good news, unless you’re a seller, is that lending standards have tightened for five consecutive quarters. In response, transaction volumes fell 21 percent in the final three months of last year. Hill and Chen observed that the sales slide, “was unusually high for a period that is typically very active.”

The prima facie evidence on extreme bond market valuation is equally compelling. Rather than delve into specifics on sovereign, corporate and emerging market bonds, we’ll let Deutsche Bank’s math speak for itself. It took a mere eight weeks through early January for the global bond market to rack up $3 trillion in losses. The swiftness of the move placed in stark perspective how hyper-sensitive bonds had become to interest rate moves. Investors should consider themselves warned.

As for stocks, the broadest valuation measure compares the market capitalization of all stocks to gross domestic product. Anything north of 100 percent denotes overvaluation making today’s reading of 127 percent disconcerting. That said, it has been higher – the ratio peaked at 154 percent in 1999 and was 130 percent in late 2015. It was, though, appreciably lower shortly before the stock market tanked. Just before the 2008 crisis, the ratio was at ‘only’ 108 percent. So make your own determination on this count. Does a relatively lower nosebleed valuation give you great comfort?

Looked at from a holistic perspective, the VIX, or so-called fear index, which reflects investors’ comfort level with stocks, flirted with single-digit territory last week. Though it did not break through 10 on the downside, which would have matched its 2007 low, the 10-handle is associated with plenty of daunting history.

“When the VIX is low and yields are falling, stocks do very well,” wrote Citigroup’s Brent Donnelly in a recent report. “When the VIX is low and yields are rising, stocks do poorly.”

That’s intuitive enough. Donnelly then goes on to compare the move in the benchmark 10-year Treasury to moves in stocks over the next 120 days. The sample set he used incorporates instances in which the VIX was less than 11 since 1990. A second step entailed comparing these occurrences to their corresponding three-month moves in the 10-year. Donnelly found that the largest three-month rise had been one standard deviation (you recall the term from Statistics 101, as in the distance from the center point on the bell curve). That is, until today.

“The craziest thing is this: Currently, the three-month rise in 10-year yields is more than 2.5 standard deviations. So based purely on this analysis, the 120-day outlook for U.S. equities is very poor.” The strength of the relationship between yields and future returns suggests stocks will fall by about seven percent over the next three months.

Like it or not, risky assets certainly appear to be sticking to the post-election, honeymoon-is-over script.

The burning question will quickly become one of, how will the Fed react? In its past life, stocks wouldn’t have to give back even 10 percent to trigger the next iteration of quantitative easing riding to the rescue. Listen to the doves’ tough talk today, though, and they sound as if they’re finally comfortable leaving risky assets to their own devices. Politics anyone?

The problem is that perhaps too much like the breakable menagerie of glass animals on display in Tennessee Williams’ play, borrowers of all stripes have amassed a veritable collection of debts throughout the market acts playing out since the Fed first lowered interest rates to the zero bound.

In an economy contingent upon conspicuous consumption, it won’t take much for the Fed to bring on a recession. The recent downtick in the personal saving rate is no cause for alarm on its own. Combine it with the steady increase in credit card spending – inflation-adjusted credit card spending has outpaced that of income growth for over a year now — and you quickly understand just how dependent continued gains in consumption are on interest rates not rising.

It’s been a mighty long time, eight years to be exact, since paper gains eviscerated the net worth of U.S. retirement savings in its various 401k, IRA and pension forms. Factor in the demographic backdrop, however, and know it won’t take long for investors to tune in to just how precious their non-yielding cash has become.

Perhaps the best news is that all heretical arguments in favor of the abolishment of cash necessarily go by the wayside during times of tightening financial conditions. After all, economic theory advocates the destruction of cash for the purpose of forcing hoarded money back into the economy. Even the illusionists at the Fed, hellbent as they are in their insistence that the economy is overheating, cannot square that circle.


Click on one of the links below to purchase Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

Amazon.com | Barnes & Noble.com | Indie Bound.com   |   Books•A•Million

 

Blinding Flash of the Obvious

Dear President Trump,

It’s conceivable you are not a regular reader of these newsletters. In deference to how busy you’ve been since last Friday, I’ll resist directing you to the full archive for the moment. Suffice it to say these missives usually begin with a catchy or sometimes kitschy cultural hook to draw readers in to such spicy subjects as bond market valuation, the prospects for monetary policymaking and one that’s near and dear for you — the state of the commercial real estate market.

But this week, in an open letter to you written in all humility, on behalf of myself and every patriotic American, I’d like to share with you the wisdom of one of our nation’s best and brightest military minds in the hopes you might adapt it to the economic issues you will be tackling during your time in office.

Lieutenant General John W. ‘Jack’ Woodmansee, Jr. served 33 years in the United States Army before retiring with the highest honors. Today, Lt. Gen. Woodmansee is the CEO of Tactical and Rescue Gear, Ltd., an 18-year old company that manufactures and sells goods to the Department of Defense, Department of Homeland Security and law enforcement markets. He’s a huge patriot if there ever was one and I’m sure you will agree we can all stand to benefit from his experience.

It is not uncommon to have mantras by which we live on our desks. When I was on Wall Street, I read and re-read mine every day, “Pigs get fat, Hogs get slaughtered.” That’s a good one, but perhaps better suited to your former day job. In your new role, which includes that of Commander in Chief of the Armed Forces, you would be better served to adopt the quotation Lt. Gen. Woodmansee uses as his guidepost to resolve “complex future requirements,” to borrow his words. (Get with me privately if you’d like to see Lt. Gen. Woodmansee’s Top Four Foreign Policy Priorities for National Security.) Without further ado, you may recognize these words as those of George Orwell:

“Sometimes the first duty of intelligent men is the restatement of the obvious.”

Let’s simplify that, military-style, in case you’re inclined to tweet this in the night. Call them Blinding Flashes of the Obvious that guide you — Bravo-Foxtrot-Oscar — to help sear the words into your memory bank. With that, what exactly are the obvious issues facing our economy? The Lt. Gen. narrowed his list to four, so I shall follow suit.

  1. The biggest challenge is what got you elected, that is the sense among millions of Americans that they’ve been on the outside looking in on the so-called economic recovery which technically started in 2009.

 

  1. Time is the second obvious element that is not on your side. Next Thursday marks the beginning of the third longest expansion in the post-World War II era. Recession will be a reality on your watch, and perhaps sooner than later.

 

  1. As you’ve recognized yourself, the financial markets are wrapped in bubble. You name it, they’re overvalued, some more than others.

 

  1. And finally, your central bank is, as my former boss Richard Fisher said, “a giant weapon that has no ammunition left.”

 

If only the solutions to what ails the economy were as glaringly obvious as what ails it. Patience and fortitude will see you through but you must prepare yourself for what’s to come. And though your initial actions do make it appear as if you believe economic prosperity can be signed into being with the whisk of an executive order, take it on faith that the country needs a lot longer than 100 days to get this economic party started.

That isn’t to say your energy industry actions aren’t to be lauded. Here’s for hoping exports are next. That natural foray accomplishes a national security aim as well. Foreign policy will be greatly strengthened if a certain egomaniac who lives east of Western Europe can no longer hold our allies hostage with the threat of their natural gas supplies being cut off in the depth of winter. Energy exporting and building those pipelines will also take us one step closer to energy independence, which is a foreign-policy and economic positive.

Then there’s the red tape that’s increasingly strangled our proud history of entrepreneurship. Please proceed to dump them at the nearest exit as you’ve promised to do. Let’s start-up and grow small businesses.

Afraid that sums up the low hanging economic fruit you can pick right away. Bringing bigly job growth back requires long term investment in educating our children in science, technology, engineering and math. Do you want to build the factories of tomorrow on American soil? Fine. Rip up the game plan and rebuild our education system, one community at a time.

If you won’t take my word for how critical this is, have a quick look at our literacy stats vis-à-vis other developed nations. As for the desire and wherewithal, Google that photo of single African-American mothers marching across the Brooklyn Bridge to retain charter school funding. Easier yet, pull up footage of this past Tuesday’s protest on the south steps of the Texas state capitol building – thousands of parents demanding tax dollars to help fund optionality in where they educate their kids. It IS broken and you’re not beholden to any special interests. Let’s fix education!

Fair warning: the recession inevitability thing won’t be easy on you. So why not bet on the come? Starting points do matter and, hate to break it to you Dorothy, but we are not back in Kansas circa 1980 anymore. Resisting radical central bank intervention will be a difficult test of your mettle. Helicopter money, negative interest rates, more bond purchases to grow the Fed’s balance sheet further, the abolition of cash. Just say no, which you can do via proxy, which we’ll get to shortly.

When it comes to recessions, we all know that discretionary spending is hit the hardest. That’s where those tax cuts and infrastructure spending you’ve committed to come in. They’re not perfect, but why not anticipate a crisis and simplify the tax code now – like tear it up and start from scratch? That’s called an uphill battle as your own party might not cotton to radical change. But you say you’re an artful master in the deal-making department. Go make one while the sun is still shining and what little time you have left remains on your side.

You’ll note that a purist’s approach to tax reform slaughters many sacred cows in the process. In the event this is intimidating, recall that thing about owing no one anything. Ask yourself a few questions. Will hedge funds, private equity firms and venture capitalists be destitute if you close the carried interest loophole? Do occupants of mansions really need the extra tax break afforded mortgage interest deductibility? And would it be better to bring a big chunk of those overseas profits back home? If you answered yes to that last question, ask around — there are ways to ensure those firms don’t simply plunk what’s repatriated back into share buybacks. We’ve seen how that stagnates economic growth, so why go there?

Tax reform will, by the way, go a long way toward dispensing with the searing criticism you face as you approach the desperate, and bonus, obvious, need to upgrade the country’s crumbling infrastructure. While you might like to have this be a purely privately funded scheme, it’s reasonable to assume that some public funding will come into play – think they call it ‘hybrid’ funding (call up your Australian counterpart for the specifics). The good news is that unlike tax cuts, which can be saved or diverted here or there, investment in bridges, tunnels, roads, schools, hospitals and the like is here to stay and keeps paying economic dividends in the form of the other business spending it induces around it. So, direct and indirect lasting economic benefits.

As for those bubblicious markets, they’re sure to be upset once they get the first whiff of that recession we just discussed. We can agree that letting the air out of the markets will be disruptive, and not in a good Uber way. There are no easy answers on this count. You might be faced with so few options that you’re forced to focus on the really heavy, preemptive, legislative lifting discussed above to mitigate the collateral damage. The best news that can be offered is that reasonably valued assets forge a natural pathway to future economic growth.

Finally, there’s the thorniest issue of all, the Fed. You may note the long road ahead is fraught with legislative barriers. To the extent financing is required, it’s always beneficial to contain borrowing costs. It would be nice to think you could rush into the Treasury market and issue a boatload of 50-year and 100-year bonds. But there are more than even odds that opportunity has been squandered by an epidemic of short-sightedness on the part of your predecessors. Let’s be magnanimous and say they didn’t appreciate the immense fiscal defenses that could have been built up against the backdrop of the lowest interest rates in 5,000 years. Deficit smoke-and-mirrors surely never came into play.

For the here and now, Fed officials seem intent on doubly tightening financial conditions by shrinking the $4.5 trillion balance sheet while raising interest rates. Knowing recessions are an inevitability should give you the resolve to offer the politically-driven doves-turned-hawks two words: “Try me.”

This done, back legislation to reduce the Fed’s mandate to minimize inflation. This will prevent future bouts of mission creep. Next, beef up bank supervision (note, never used word “regulation”) to stay one step ahead of nefariousness. And finally, fill those two open vacancies on the Board, and fast, with individuals who don’t think “no” is a four-letter word. Bring dissent back to the Fed by installing the best and brightest, who also happen to have uncompromising constitutions. Let the new kids on the block carry out your leadership of the Fed by proxy.

Tall orders, one and all? Without a doubt. But at least you’ve got hope, ebullience and inspiration on your side. Surveys of businesses and households suggest you’ve even got the fillip of an economic acceleration in the cards. So seize the moment and embrace the fact that you don’t require a lot of sleep to effectively lead. The hardest deals of your lifetime lie ahead. Don’t back down for all our sakes. And keep Orwell’s words in mind if wily politicians try to bog you down in the weeds. Bravo-Foxtrot-Oscar. An added bonus: it makes a great Tweet.

Sincerely,

We the People

 

PS – for a more detailed road map to upending the Fed, Click “Fed Up” – happy to chat in person at your convenience.

Bloomberg: Heed the Fed’s Balance Sheet Banter

Heed the Fed's Balance Sheet Banter, DiMartino Booth, Money Strong, Fed Up

Dear friends,

How is it exactly that we’ve journeyed from Uber-Doveville to life on Tightening Row? My answer is, “You tell me.” In the space of one election, Fed officials have metamorphosed from crying for fiscal stimulus to opining that the economy doesn’t really need all that much help after all from fiscal authorities.

The outlook has, in fact, improved so much that the unheard of, the sacrosanct, is now reasonable. Yes, if you have to ask, I speak of the precious balance sheet that was protected as is it were the very Ark itself. It, too, now is fair game to shrink.

If it looks like double tightening and sounds like double tightening, well then, by golly that’s what it is. The economic recovery is now so durable it can not only handle rising interest rates but an absent Fed in the Treasury and mortgage-backed securities in which it’s been ever present since the zero bound was hit back in 2008.

Yes, it is time to pinch yourself or ask if politics is so blatant as to be conspicuous in its very presence. For an explanation of this cryptic concoction, please read an opinion piece published yesterday.

Heed the Fed′s Balance Sheet Banter

https://www.bloomberg.com/view/articles/2017-01-23/heed-the-fed-s-balance-sheet-banter

Best,

Danielle