Monday, December 17, 2018

Fed squeezed between still-growing economy, falling stocks, and higher deficits

All of a sudden, this week’s Open Markets Committee meeting of the Federal Reserve is taking on extra notice. The Fed had been raising interest rates in a consistent manner throughout much of 2018 as the economy has been in full employment along with a tax cut-fueled Bubble, and it was anticipated the tightening would continue with another ¼ point increase on Wednesday.

But now with the stock market stumbling and political developments in turmoil, a former Fed official asked over the weekend to stop the tightening.
The Federal Reserve should halt its interest rate increases as recent developments in the markets and economy signal caution, hedge fund manager Stanley Druckenmiller said in a commentary for the Wall Street Journal over the weekend.

"The central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity," Druckenmiller, a former member of the Fed Board and now CEO of Duquesne Family Office, said in the op-ed…

The S&P 500 [was] down 11 percent [going into today] and counting from its record high hit earlier in the year as recession fears mount. Bank stocks have led the decline with the financial sector in the S&P 500 down more than 20 percent over that same time span. Other economically sensitive sectors, like housing, transport and industrials, are down by double digits, underperforming the broader markets, Druckenmiller pointed out in the op-ed.

Markets are now foreseeing a 78 percent chance of a hike when the Federal Reserve meets on Wednesday and a 38 percent probability of a move anytime in 2019, according to the CME's tracker. The Fed has forecast three hikes for 2019, but recent dovish comments from Fed officials and a more tempered view of the economy for next year could make them rethink their rate path.

"The Fed should stop this option-limiting exercise entirely. And if data dependence is the Fed's new mantra, it should actually incorporate recent data into its forthcoming policy decision," Druckenmiller added.
And then there was another 500+ point decline in the DOW today, with similar 2%+ drops in other indexes. The S&P 500 has now gone down 8.75% over the last 2 weeks and nearly 13% since the start of October, while the smaller-cap Russell 2000 officially entered Bear Market territory with a 20% decline less than 4 months.


That’s going to cause a lot of shock when people look at their portfolios at the end of the year. But the problem is that Druckenmiller’s comments also came on the heels of reports that counteracted some shakiness the US economy from the week before ( I outlined the shakiness here, mostly involving the housing market and a rising trade deficit). Among those reports included softening inflation for consumers, with no change in prices for November, the first time that’s happened since March, and 12-month inflation at its lowest level since February at 2.2%.

Ordinarily, you would think that the lower inflation would lead to a quicker end to the Fed tightening interest rates, but if you dig into that report, it shows that the biggest reason for it is due to plummeting gas prices that we’ve seen over the last month. If you strip out food and energy prices and go with “core” inflation (which the Fed likes to do), then prices were up a typical 0.2% last month and 2.2% over the last 12months – basically the same as it has been in for much of 2018.

Then you cross over that low topline inflation figure with slightly stronger wage numbers in the last 2 jobs report, and you get this information.
Real average hourly earnings for all employees increased 0.3 percent from October to November, seasonally adjusted, the U.S. Bureau of Labor Statistics reported today. This result stems from a 0.2-percent increase in average hourly earnings combined with no change in the Consumer Price Index for All Urban Consumers (CPI-U).

Real average weekly earnings decreased 0.1 percent over the month due to a 0.3-percent decrease in the average workweek offsetting the increase in real average hourly earnings.

Real average hourly earnings increased 0.8 percent, seasonally adjusted, from November 2017 to November 2018. The change in real average hourly earnings combined with a 0.3-percent decrease in the average workweek resulted in a 0.5-percent increase in real average weekly earnings over this period.
The 0.8% increase in real hourly earnings is welcome to hear, as that’s been a lagging part of the economy for quite a while. It’s the largest 12-month increase in real earnings that we’ve seen in 2018 so far, and the 3.1% nominal increase is the highest we’ve seen in 9 ½ years.

In addition, retail sales were good for November (+0.5% outside of gas stations), and October was revised notably higher, which indicates the consumer was holding up as Holiday shopping season began. This along with the tamer inflation were big reasons why the Atlanta Fed revised up its growth estimates for Q4 GDP to 3.0% from 2.4% late last week.


Here’s another variable that argues in favor of continuing to tighten – the US’s budget deficit keeps growing higher, even with this economic and income growth. The US Treasury Statement for November came out on Thursday, and it showed the GOP’s Tax Scam keeps failing to pay for itself.
The U.S. posted the widest November budget deficit on record as spending doubled revenue.

Outlays jumped 18 percent to $411 billion last month, while receipts were little changed at $206 billion, the Treasury Department said in a monthly report on Thursday. That left a $205 billion shortfall, compared with a $139 billion gap a year earlier…

In the first two months of the fiscal year that began Oct. 1, the gap widened to $305.4 billion, compared with $201.8 billion the same period a year earlier.
A little of that increase in the deficit is due to calendar items, but the bottom line is that Uncle Sam needs someone to take on all of that debt to keep running deficits like that. So in theory interest rates would have to go up to encourage more people to give the US the hundreds of billions it needs every month to pay the bills, given that not enough taxes are coming in to do it.

So the data would indicate the present economy is growing enough to warrant the Fed continuing on their path of a few more increased short-term interest rates. But the bigger things blow up, the harder they fall, which likely means the chances of a slowdown in 2019 become higher.

And is the Fed going to be able to avoid the temptation of holding off, and giving some relief to Wall Streeters who are reeling from another major selloff today? Now add in the spectre of a government shutdown lurking at the end of this week, and will the Fed be spooked into trying to keep the lending spigot open in an attempt to prevent markets from getting worse and more panicky before the end of the year (and options expiring on that same Friday)?

You can see the squeeze we’re in, as the overall economy and our rising budget deficits don’t warrant any more stimulation, but our financial markets and corporations are seeing their bubbles bursting, and the question is whether their bleeding needs to be stopped. There’s no good way out of this that won’t cause problems in the near future.

1 comment:

  1. I haven't checked it for a while, but also compare potential GDP to GDP: the latter has now exceeded the former - symptomatic of the GOP stimulus of an economy already at full output - a situation that has immediately preceded the last two recessions.

    Then there's the 10 year - 2 year and 10 year - 3 month yield curves threatening to invert, just as they do prior to recessions.

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