That the Federal Reserve is important for the levitating asset prices in today`s markets are beyond doubt, but just how important may come as a surprise to the most astute Fed watcher. In order to quantify the impact the Federal Reserve has had on financial markets we have come up with a simple, but solid test.
Since January 3rd 1994 there have been 4,906 trading days for the Standard and Poor`s 500 index. Over the same time span there have been 126 days containing a press release from the Federal Open Market Committee (FOMC). Now, let`s say the S&P500 did not trade on the day of the press release and the following day. That leaves 252 days out of 4,906, or 5.1 per cent, with no change to the index. If we then compare an unaltered S&P index (the one with 4,906 trading days) with an adjusted index which saw zero change on 252 days we get the following chart:
Source: Bloomberg, Federal Open Market Committee (FOMC)
As of June 27 2013 the unaltered index read 1,613.2 points while the FOMC-adjusted index read only 999.55 points; a staggering 61 per cent difference. In other words, the FOMC policy, that once was seen as taking away the punchbowl when the party got started, have under the watchful eye of Greenspan and his successor Bernanke been more akin to adding liquor in order to spice up the punch every time the party was about to end.
In an interview on CNBC February 2013 Alan Greenspan claims that stock prices causes’economic growth presumably through some sort of wealth effect. The Fed seem to be targeting asset prices much more than real economic variables such as employment in their quest to maintain status quo.
The problem with this interconnectedness, at least for the longs, is the inevitable scale-back or taper as they call it, the FOMC must at some point engage in. While the FOMC has tried to communicate their intentions at several occasions’ markets did to pay attention, until May 22nd when the Chair-Satan himself spoke to the minions at the Joint Economic Committee. Mr. Bernanke hinted quite strongly that the day of reckoning would at some point come. Markets, always keen to front run the treasury buyer of last resort, started to head for the door. However, it wasn`t until the press conference following the FOMC June meeting things started to get really bad. We quote from the transcript:
If the incoming data are broadly consistent with this [FOMC] forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid growth supporting further job gains, a substantial improvement from 8.1 percent unemployment rate that prevailed when the Committee announced this program [QE∞]
Mr. Market was shocked of the imminent withdrawal of free money and the volatile sell-off continued unabated. Now, a careful reading of the transcript suggest that Mr. B is far more cautious as he repeatedly point to the fact that “tapering” is a function of the underlying fundamentals and as such tied to whether the overly optimistic FOMC forecast is fulfilled or not. Needless to say, it will not come to fruition and there is zero chance the QE program will come to a full stop by next year! Tapering, yes, but only because the federal government has reached its debt ceiling and cannot issue new debt. On a flow perspective, the Fed will simply be too big in a world with zero new issuance.
According to the press release the FOMC expects gross domestic consumption (GDC) to grow by around 2.5 per cent in 2013 and with the latest downward revision to first quarter GDC this look like a fairy tale number already. In addition, if you look at the national activity index one should expect an even weaker reading in the second quarter. For the FOMC forecast to come in at 2.5 per cent, growth must average 3.4 per cent in both the third and fourth quarter.
Unemployment by year end will, again according to the latest FOMC forecast, be around 7.3 per cent; only 30 points away from a complete standstill in additional QE flow. Based on the recent trend in participation rate this forecast may be more aligned with reality than the GDC forecast.
Source: Federal Open Market Committee (FOMC)
While there seem to be a mathematical difficulty in achieving the forecasted growth announced, there is a more fundamental reason for why the FOMC will feel forced to expand the program not long after the taper has taken place. Money creation, be it from the central bank or the fractional reserve “commercial” banking system, leads to anothing for something transaction. Subsequently, the demand pattern created out of this devious transaction consumes capital and is per definition unsustainable. As soon as the money flow is tapered off, the unsustainable demand will dissipate and real resources need to reallocate within the economic system. Since resource reallocation takes time, production will take a temporary hit, but this process is what Mr. B calls recession and must according to him be avoided at all cost. The FOMC will engage in a taper, but less than six months later the debate will focus more on how much to increase the monthly purchases above the current level of $85bn.
Given the recent market turmoil, we have seen backtracking from some prominent members of the FOMC already. Most notably of them is bankster friend Mr. Dudley from the New York Federal Reserve. In a speech held June 27 he simply told market expectations of a fed fund hike early in 2015 to be “out of sync with both FOMC statements and the expectation of most FOMC participants.” Further, he stressed that the FOMC scenario for economic growth is just one possible outcome out of many. Yes, and the FOMC scenario is of the less likely sort.
But the most important thing he said refers to the labour market. When the FOMC defended its policies it pointed to the impressive improvement in the unemployment rate. That the whole “improvement” was due to people leaving the labour force (statistical speaking) were never mentioned. Now, that they need to maintain optionality in terms of QE taper this has become a hot topic among our Central Bankster friends.
“Recall that discouraged workers who do not actively look for work are regarded as not participating in the labor force and so are not counted as unemployed even though they are without jobs. Using an alternative measure, the employment to population ratio, which is not influenced by changes in the number of discouraged workers, there has been limited improvement in labor market conditions”
He is right, but we knew it three years ago and they knew it too. It has just become convenient to bring this up now.
Okun`s law has broken down, and this is not because the US economy can produce well-paying jobs to the great majority of people at sub-par GDC growth. It is because the statistic is messed up.
Source: Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), own calculaitons (Kudos to ZeroHedge for pointing out the breakdown in Okuns “law”)
The recent talk of tapering QE-eternity will come to naught. Yes, they will try to taper bar a massive shock (such as sub-100k NFP this Friday) but only because the treasury issues no new papers at the moment.
When the taper lead to restructuring of resource flow to a sustainable something for something transaction, then they will soon be back to a new level.
Do not sell your gold quite yet.